Think about options on futures contracts and their premiums, and specifically ab
ID: 1119818 • Letter: T
Question
Think about options on futures contracts and their premiums, and specifically about intrinsic value and time value.
How does the intrinsic value for puts and calls change as the underlying futures price changes?
How does the intrinsic value for puts and calls change as the option contract approaches its expiration day?
How does the time value for puts and calls change as the underlying futures price changes?
How does the time value for puts and calls change as the option contract approaches its expiration day?
Today a put on the soybean futures contract for January delivery with strike $8.90/bu is trading at $0.37/bu (premium). Knowing that the futures price for January delivery is now $8.59/bu, what should happen with the premium of this put if the underlying futures contract keeps going up until its expiration? Make sure to explain what should happen to both intrinsic and time value.
Today a put on the corn futures contract for March delivery with strike $3.60/bu is trading at $0.11/bu (premium). Knowing that the futures price for March delivery is now $3.66/bu, what should happen with the premium of this put if the underlying futures contract starts going down until its expiration? Make sure to explain what should happen to both intrinsic and time value.
Explanation / Answer
The value of an option after subtracting the strike price from its present value is known as the Intrinsic value.
Considering the case of a Call option, as and when the value of the underlying futures contract increases or decreases, the intrinsic value is likely to increase or decrease simultaneously.
While in case of a Put option, this will be reversed i.e., the option value will be cutback by the increasing price and vice versa.
A near expiration option will fall in value with inflow and outflow of money options.
The time value of puts and calls are maximum when money options are concerned. While the intrinsic value is zero.
Soybean Futures Contract
Value of Put option, p = $0.37/bu
Strike price = $8.90/bu
Value of Futures contract = $8.59/bu
Therefore, value of put option = Strike price - Value of Futures contract = 8.90 - 8.59 = $0.31/bu.
The intrinsic value of this option declines with an increase in the value of the put option. As the put option nears expiration, its time value also declines.
Corn Futures Contract
Value of Put option, p = $0.11/bu
Strike price = $3.60/bu
Price of Futures contract = $3.66/bu
The intrinsic value of the put option increases when the price of contract declines.
Value of put option, p = Strike Price - Value of Futures Contract
According to the time value of money concept, as the option nears expiration, the time value of money declines.
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