(Last Updated On: July 16, 2015)

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Remember intrinsic value was always positive.

Intrinsic value plus time value equals premium

Intrinsic value is positive or zero

Intrinsic value depends on the probability that an option will be exercised largely depends on time to maturity and price volatility of underlying futures

Intrinsic value depends on the relationship between the strike price and the underlying futures price

General and options premium will never be less than intrinsic value

The longer the time to maturity the higher the premium will be. If you look at two contracts look at T bond for a corn contract, there could be more price volatility in the T-bond. Where there’s more volatility you’ll see more time value if everything else held equal. The more volatile the underline price with a certain time until expiry there will be a probability the option will move into the money. The more volatile of the underlying price, it will move into the money. If court is quite stable with a option that is deep out of the money. If the strike in the future price is \$.20 per bushel, it becomes deep out of the money. If it is not a volatile market there will be a small probability it will move into the money. If you compare that to the T-bond which is highly volatile and deep out of  the money, Given the volatility there is a reasonable probability that it will be in the money. These are the two factors that determine The time value.

Intrinsic value is the relationship between The strike price and futures price which also depends on if it’s a call or put.

The premium will never be less than the intrinsic value even his time Vallue was zero.  If not the market is not operating efficiently.

Components of time value are:

Time

Volatility

Interest rates

Supply and demand for the option

You can use the black scholes formula to find a fair premium.

Options are referred to as decaying assets. Time erodes as you approach expiry.

If you’re in the market with volatility it will have my time value. For the writer of the option who is 12 months out, the writer of the option us to figure out the probability of moving into the money. The probability you will likely be high so the premium will be high too. As you approach expiry there’s more uncertainty is narrowed down. If it’s two weeks before expiry but still out of the money,  for corn it will have a higher probability it will stay out of the money.

For the writer of the option there is also the Delta factor which measures the extent to which an option premium will move with the underlying futures price. If you have a futures option with the futures price of corn is two dollars a bushel for a March contract, if you have a call option with the strike of \$2.20. This means you have the right to go long at \$2.20. That option is now out of the money. Instead of buying future you buy an option, you purchase the call option. If next day the futures is up five cents the options premium will not move by five cents. Delta value option will likely be less than five cents. It could be four cents which means there’s a 40% change in the options market.

If There was a call option and was deeper out of the money at \$2.40 strikes but The price is two dollars. The futures market moves up five cents but the options we only changed by one penny.   There is a high probability the options will stay out of the money but the premium does not move that close to the futures price. Alternatively we had an option deep in the money, it had a call at strike of \$1.80 for a two dollar futures so there is an intrinsic value of \$.20, there is a high probability will stay in the money. If there’s a high probability that it will stay in the money, the Delta factors usually one.

The writer of the option is assessing the probability of staying in or out of the money. The Delta factor will be near 1. If it will stay out of the money Delta factor will remain very low. If it is at the money the Delta factor is .5 which reflects a 50% chance of moving in or out of the money.

You use historical price behavior to calculate the Delta factor so you watch the pricing of previous days. You also need to figure out how the premium has has responded.

Futures versus options so refer two attached chart.

We want to determine intrinsic value to see if an option is in or out of the money. We work with payoff charts that facilitates showing the outcome to holding call or put. This includes hedging. We will use charge to show how the value of an option will change over time in a given futures price.

you have the futures price at expiration on the horizontal axis versus profit or loss on the vertical. This is a 45° line which reflects the payoff to the buyer of the futures contract. It crosses the horizontal axis at the price with the contract was entered into

If you buy into a crude oil futures contract at \$30 a barrel, this is where it crosses the horizontal axis. If the price goes up by five dollars a barrel, the profit will be five dollars per barrel. This is how you show a payoff for a futures contract.if you long it’s upward sloping, if it’s short it’s downward sloping.

You can add a pay off chart to a call option.refer to attached chart. The bottom kink line shows the payoff to a buyer of a call. It has a flat spot that reflects if The price stays low, it will be out of the money. Your premium will shift down your expected pay off. Remember in a futures contract you don’t pay a premium. When you buy an option you will automatically be behind the curve because of the premium to be paid out.

If you have a a crude contract The pay is \$30 per barrel there is a \$30 strike the premium is five dollars. That contract has to move into the money by five dollars before you break even. The kink line is then Kinked at the strike price. If you buy the right to go long on a \$30 futures contract, if the Price of oil is at \$15 per barrel you would not exercise the option at all. As it approaches your strike towards \$30 being in the money, it moves to the right of the strike price which becomes in the money. After the strike price your return moves into positive territory. But it has to move my five dollars in order to breakeven. So if your strike price is \$30 plus the premium at five dollars, the breakeven point is \$35.

If the option is not exercised. You do not exercise the option if The strike price is \$30, you pay five dollars for it but the futures is a \$25. So if the futures price does not change but you are buying the right to go Long At 30.you have no interest of being a long at at \$30 but the futures price is a  \$25. If you exercise the option you will lose five dollars. That option is out of the money. If you hold that option until expiry where it is out of the money since the futures price stays at \$25, the option becomes worthless. The writer of the option gains five dollars.

Referred to the chart of buyer of a put option.

If the strike price is \$30 for crude oil. If the futures price is high it’s out of the market. It is low it is in the money. So you’re buying the right to to go short at \$30. You’ll exercise that right if the futures price falls below \$30 do you want to sell at \$30 and buy a lower  price. So you want this option move into the money. Pay off chart has shifted below the horizontal axis by the amount of the premium to an arbitrary level of five dollars.if it goes to \$30 it is at the money. If it falls below \$30 or strike price it is now in the money. If it falls to \$25 you are breaking even since this is the breakeven price. Once it hits the price of the strike at The kink of the line, it will move up at the 45° angle where u start to to gain a return.  Is also shifted over for the payoff chart to the seller of the futures contract by The amount of the premium. If you sell the futures contract at \$30 but the price falls by five dollars, you will make a five dollar profit. This is why it is a 45° line. If you buy a put option with the \$30 strike price the price has to fall to \$25 before you break even. You can see by this graph that speculators of options may not be the ideal way to invest into these markets because you have to pay this premium. There is no free lunch.

If you’re paying a premium for five dollars and you’re right where the price falls, all you get is your premium back. As opposed you could’ve sold the futures contract if the price fell by five dollars, you would’ve made \$5000 in one contract because there  is no premium.

The advantage as you’re buying a put is if you were wrong the market moves up where the future as price goes to \$40, the most you’ll lose is your premium. That is reflected on your payoff chart at the flat part of the line. It does not matter what happens to the price as you will only lose five dollars. With the futures contract the losses will pileup as that price rises as you move down that 45° line. An advantage of a put is that the losses are limited with the premium. If the market moves in the direction of what you predict it will take a certain move just get your premium back before you get profit

Options example:

Corn put

Speculator expects prices to fall amd buys a march put at 13 3/4 cents price at strike 2.50

Premium is 13 3/4 cemt x 5000 bu =\$687.50

Underlying march futures price is \$2.40

Remember intrinsic value was always positive.

Intrinsic value plus time value equals premium

Intrinsic value is positive or zero

Intrinsic value depends on the probability that an option will be exercised largely depends on time to maturity and price volatility of underlying futures

Intrinsic value depends on the relationship between the strike price and the underlying futures price

General and options premium will never be less than intrinsic value

The longer the time to maturity the higher the premium will be. If you look at two contracts look at T bond for a corn contract, there could be more price volatility in the T-bond. Where there’s more volatility you’ll see more time value if everything else held equal. The more volatile the underline price with a certain time until expiry there will be a probability the option will move into the money. The more volatile of the underlying price, it will move into the money. If court is quite stable with a option that is deep out of the money. If the strike in the future price is \$.20 per bushel, it becomes deep out of the money. If it is not a volatile market there will be a small probability it will move into the money. If you compare that to the T-bond which is highly volatile and deep out of  the money, Given the volatility there is a reasonable probability that it will be in the money. These are the two factors that determine The time value.

Intrinsic value is the relationship between The strike price and futures price which also depends on if it’s a call or put.

The premium will never be less than the intrinsic value even his time Vallue was zero.  If not the market is not operating efficiently.

Components of time value are:

Time

Volatility

Interest rates

Supply and demand for the option

You can use the black scholes formula to find a fair premium.

Options are referred to as decaying assets. Time erodes as you approach expiry.

If you’re in the market with volatility it will have my time value. For the writer of the option who is 12 months out, the writer of the option us to figure out the probability of moving into the money. The probability you will likely be high so the premium will be high too. As you approach expiry there’s more uncertainty is narrowed down. If it’s two weeks before expiry but still out of the money,  for corn it will have a higher probability it will stay out of the money.

For the writer of the option there is also the Delta factor which measures the extent to which an option premium will move with the underlying futures price. If you have a futures option with the futures price of corn is two dollars a bushel for a March contract, if you have a call option with the strike of \$2.20. This means you have the right to go long at \$2.20. That option is now out of the money. Instead of buying future you buy an option, you purchase the call option. If next day the futures is up five cents the options premium will not move by five cents. Delta value option will likely be less than five cents. It could be four cents which means there’s a 40% change in the options market.

If There was a call option and was deeper out of the money at \$2.40 strikes but The price is two dollars. The futures market moves up five cents but the options we only changed by one penny.   There is a high probability the options will stay out of the money but the premium does not move that close to the futures price. Alternatively we had an option deep in the money, it had a call at strike of \$1.80 for a two dollar futures so there is an intrinsic value of \$.20, there is a high probability will stay in the money. If there’s a high probability that it will stay in the money, the Delta factors usually one.

The writer of the option is assessing the probability of staying in or out of the money. The Delta factor will be near 1. If it will stay out of the money Delta factor will remain very low. If it is at the money the Delta factor is .5 which reflects a 50% chance of moving in or out of the money.

You use historical price behavior to calculate the Delta factor so you watch the pricing of previous days. You also need to figure out how the premium has has responded.

Futures versus options so refer two attached chart.

We want to determine intrinsic value to see if an option is in or out of the money. We work with payoff charts that facilitates showing the outcome to holding call or put. This includes hedging. We will use charge to show how the value of an option will change over time in a given futures price.

you have the futures price at expiration on the horizontal axis versus profit or loss on the vertical. This is a 45° line which reflects the payoff to the buyer of the futures contract. It crosses the horizontal axis at the price with the contract was entered into

If you buy into a crude oil futures contract at \$30 a barrel, this is where it crosses the horizontal axis. If the price goes up by five dollars a barrel, the profit will be five dollars per barrel. This is how you show a payoff for a futures contract.if you long it’s upward sloping, if it’s short it’s downward sloping.

You can add a pay off chart to a call option.refer to attached chart. The bottom kink line shows the payoff to a buyer of a call. It has a flat spot that reflects if The price stays low, it will be out of the money. Your premium will shift down your expected pay off. Remember in a futures contract you don’t pay a premium. When you buy an option you will automatically be behind the curve because of the premium to be paid out.

If you have a a crude contract The pay is \$30 per barrel there is a \$30 strike the premium is five dollars. That contract has to move into the money by five dollars before you break even. The kink line is then Kinked at the strike price. If you buy the right to go long on a \$30 futures contract, if the Price of oil is at \$15 per barrel you would not exercise the option at all. As it approaches your strike towards \$30 being in the money, it moves to the right of the strike price which becomes in the money. After the strike price your return moves into positive territory. But it has to move my five dollars in order to breakeven. So if your strike price is \$30 plus the premium at five dollars, the breakeven point is \$35.

If the option is not exercised. You do not exercise the option if The strike price is \$30, you pay five dollars for it but the futures is a \$25. So if the futures price does not change but you are buying the right to go Long At 30.you have no interest of being a long at at \$30 but the futures price is a  \$25. If you exercise the option you will lose five dollars. That option is out of the money. If you hold that option until expiry where it is out of the money since the futures price stays at \$25, the option becomes worthless. The writer of the option gains five dollars.

Referred to the chart of buyer of a put option.

If the strike price is \$30 for crude oil. If the futures price is high it’s out of the market. It is low it is in the money. So you’re buying the right to to go short at \$30. You’ll exercise that right if the futures price falls below \$30 do you want to sell at \$30 and buy a lower  price. So you want this option move into the money. Pay off chart has shifted below the horizontal axis by the amount of the premium to an arbitrary level of five dollars.if it goes to \$30 it is at the money. If it falls below \$30 or strike price it is now in the money. If it falls to \$25 you are breaking even since this is the breakeven price. Once it hits the price of the strike at The kink of the line, it will move up at the 45° angle where u start to to gain a return.  Is also shifted over for the payoff chart to the seller of the futures contract by The amount of the premium. If you sell the futures contract at \$30 but the price falls by five dollars, you will make a five dollar profit. This is why it is a 45° line. If you buy a put option with the \$30 strike price the price has to fall to \$25 before you break even. You can see by this graph that speculators of options may not be the ideal way to invest into these markets because you have to pay this premium. There is no free lunch.

If you’re paying a premium for five dollars and you’re right where the price falls, all you get is your premium back. As opposed you could’ve sold the futures contract if the price fell by five dollars, you would’ve made \$5000 in one contract because there  is no premium.

The advantage as you’re buying a put is if you were wrong the market moves up where the future as price goes to \$40, the most you’ll lose is your premium. That is reflected on your payoff chart at the flat part of the line. It does not matter what happens to the price as you will only lose five dollars. With the futures contract the losses will pileup as that price rises as you move down that 45° line. An advantage of a put is that the losses are limited with the premium. If the market moves in the direction of what you predict it will take a certain move just get your premium back before you get profit

Options example corn put

Speculator expect prices to fall and buys a march put at 13 three-quarter cents. Price of stroke \$2.50.  Premium is 13 three-quarter cents times 5000 bushels.

You expect prices to fall you put a short. You buy an option to put if you expect prices to fall. If you expect prices to rise you get a option call. On the horizontal you have the futures price. You have a strike price of \$2.50.. The expected pay off line will always be Kinked at the strike price. The payoff is the Orange line. That shift down below the horizontal axis by The amount of the premium. This is on 13 and three-quarter cents times 5000 bushels. Total \$687.50. This is your cost of the option. If the price falls to \$2.36 two cents you’ll get your money back. This premium is quite high it would take a large price drop to get your money back. If the price falls to \$2.26 you make \$.10 per bushel.

Option example: yen put

You expect the dollar to increase and you buy a march put a dollar 65 per ¥100. Strike price at \$.01035 per yen. Premiums equal to .000165 per yen times 12 1/2 thousand dollars per yen equaling \$2062.5 Underlying price futures price is equal to \$.0103 per year

If US dollar rises the US

Vdollar per yen and will fall. The dollar increases the dollar per yen and will fall so each yen will cost you if you fewer dollars. This is why you would buy a put. So if the strike price is \$.01035 per Japanese yen

For the attached graph your expected payoff is to the left because you expect the price to fall for profit. The line is kink that the strike price. You calculate your breakeven price which is the difference between the strike and the premium. You subtract the premium from the strike price so the market must fall by that amount to break even. This is .01018 cents. If it keeps falling below that price you will start to make a profit.

Option examples: T bond call

Do you expect interest rates the fall by a Mar call at One – 41 and a strike price of 100–00. Premium is equal to 1–41 64ths at \$15.62 equaling \$1640

Underlying March futures price is 99–18. Remember options are in 64ths versus futures are 32nds. each 64th is worth \$15.62 by dividing the \$31 one divided by 25 divided in half since each 32nd is equal to \$31.25. If you multiply \$15.62 times 64, it should equal \$1000. If the premium is 1–41 the premium should range between \$1000-\$2000. The underlying March futures price is is 99–18 so draw your payoff chart to show words in or out of the money. So the strike price 100–00, premium is \$1640. Remember futures are in 32nds since the horizontal axis is in the futures price. So if your strike is 100–00, The premium you paid is 1–41 64ths , So divide that 41 in in half, it should equal to 20 32nds. This is why the breakeven is set at 101–20. It is out of the money to the left of the strike price. It is in the money to the right of the strike price. Still say it is in the money even though it has not hit the break even point.

Premium is 1–41 or 1 41/64 since it is an option is priced in 64th. Each 64th is worth \$15.62. Each 32nd is worth \$31.25. T bond futures are priced in 32nd where each is Worth \$31.25. 31.25 x 32 is equal \$1000. The face value is worth \$100,000 and the pricing is percent per par. Total premium is equal to 1000+41 times times 15.62 equals \$1640 for total premium. The breakeven prices and 32 seconds since it’s on the future market.

To calculate breakeven price:

One – 20÷32 is approximately equal to 1×41÷64

Another example is if your premium is     1 10/64ths breakeven will equal 1 5/32

If you futures prices at 99–18, in the above example it should be out in the money

In the money: call options 50,000 pounds cents per pound refer to attached photo

The prices are cents per pound. The options that are out of the money that are listed the bottom right. You need to know which options are in or out of the money. If you look at the merge calls, if the strike price is \$54 while the March futures is at 56.55. You will make a positive return if you exercise if you long at \$54 so you will sell at \$56.55. You can make a profit strike price of \$55 or \$56. If you see the calls within the Orange line, those are in the money to the may call. March call at \$57 strike price, it will be out of the money

if you use the strike price of \$57 with mar call of premium \$3.55 but the May futures is that \$57.35, you will be in the money. You could sell it 57.35 to earn a small return.The July future is \$58.10 so the July call 58 is still in the money.

For puts it is the opposite that will be in the money. For call options with the low strikes will be in the money.  Does puts with high strike prices are usually in the money so they will tend to have higher premiums. For the points you’ll see the premiums get higher which move from out of the money into the money. The ones that are deeper in the money will have a higher premium.

With calls is just the opposite, when you move from a low strike price the premiums should rise because you go to a low strike price so that option becomes deep in the money.

If you have a July future price of \$56.10 the low strike price of 54 for a call option will have a high premium 6 to be deep in the money. You’ll have a high premium at the top in the case of calls with a high premiums will be near the bottom for the puts. There is a relationship here with the march call with a strike of 56 and march put with a 56 strilke. Yeah we are looking at the futures price and the strike. You know that with calls, if the futures above the strike you are in the money. With ports it’s the opposite.

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