If the futures price drops below the strike price, the option buyer will not exercise the option because exercising will create a loss for the buyer. The buyer of a put option will make money if the futures price falls below the strike price. The seller of a call option loses money if the futures price falls below the strike price.
If the futures price rises above the strike price, the option buyer will not exercise the option because exercising will create a loss for the buyer.
The intrinsic value is the amount of gain that can be realized if the option is exercised and the resulting futures position closed out. Extrinsic (extra) value is the amount by which the option premium exceeds the intrinsic (exercise) value.
Below are examples of call and put options that are in-the-money, at-the-money, and out-of-the-money.
Below are actual examples of soybean option premiums for various strike prices and delivery months. The options with strike prices at-the-money and out of-the-money have premiums containing no intrinsic value (exercise value.) Only those options that are in-the-money have premiums with intrinsic value. This occurs because the August option will be traded for a longer period of time than the July option. An option trader who is writing a call option for $6.50 will be liable for exercise value if the futures price increases by only one cent.
If the rise is more than the cost of the premium and transaction, the buyer has a net gain. In this situation the option buyer will let the option expire worthless on the expiration day.
If the decline is more than the cost of the premium and transaction, the buyer has a net gain.
In this situation, the option buyer will let the option expire worthless on the expiration day.
The option buyer pays the premium to the option writer (seller) at the time of the option transaction.
A call option has intrinsic (exercise) value if the futures price is above the strike price. Extrinsic value is the return that option writers (sellers) demand in return for bearing the risk of loss from an adverse price movement.
These option terms pertain to the relationship between the current futures price and the strike price.
In other words, a call option is in-the-money if the current futures price is above the strike price because it can be exercised at the strike price and sold at the current futures price for a gain. A one cent change in the future price will put the option either in-the-money or out-of-the-money.
The time period from March 1 to mid July, when the August option expires, is four and one-half months. They demand a higher return (premium) for bearing this risk for a longer time period, especially considering that June and July are usually periods of price volatility due to the crop growing season.
It is only 14 cents for the 50 cents out of-the-money option ($7 strike price option) and 8 cents for the 50 cents in-the-money option ($6 strike price option).
However, by writing a $7 option, the futures price will have to rise by over 50 cents before the writer will be liable for exercise value. The option seller (writer) must take the opposite side of the option buyer’s futures position. For example, if you choose a soybean option with a strike price of $7 per bushel, upon exercising the option you will buy or sell futures for $7. For example, corn options have December, March, May, July, and September delivery months, the same as corn futures. The amount of gain or loss from the transaction depends on the premium you paid when you purchased the option and the premium you received when you sold the option, less the transaction cost.
The amount of gain or loss from the transaction depends on the premium you received when you sold the option and the premium you paid when you repurchased the option, less the transaction cost. The seller (writer) of the call option must sell futures (take the opposite side of the futures transaction) if the buyer exercises the option.
The only money transfer will be the premium the option buyer originally paid to the writer. The writer (seller) of the put option must buy futures (take the opposite side of the futures transaction) if the buyer exercises the option.
The only money transfer will be the premium the option buyer originally paid to the seller.
A put option has intrinsic (exercise) value if the future price is below the strike price.
Conversely, a put option is out-of-the-money if the current futures price is above the strike price.
In parentheses are the intrinsic (exercise) value and the extrinsic value for each option premium. Futures price would have to rise by over 50 cents before the option would contain any exercise value. The time period from March 1 to mid June for the July option is only three and one-half months.
So the extrinsic value decreases as the option moves further out-of-the-money or in-the-money.
So the writer will demand a higher return (extrinsic value) for writing an at-the-money option. The date on which the option quotes were taken (March 1) and the futures prices ($6.50) are also the same.
For example, if you buy an option with the right to buy futures, the option seller (writer) must sell futures to you if you exercise the option. Option contracts are traded in a similar manner as their underlying futures contracts.
However, you run the risk of having the option exercised by the buyer before you offset it.
Because of extrinsic value, an option buyer can sell an option for as much or more than its exercise value.
If this option is exercised, the option buyer will own a futures contract purchased at a strike price of $6.
All buying and selling occurs by open outcry of competitive bids and offers in the trading pit.
The option writer (seller) takes the opposite side (sell) of the futures position at the strike price. The premium is the maximum amount the option buyer can lose and the maximum amount the option seller can make. This occurs because exercising a put option places the option buyer in the futures markets selling (rather than buying) futures at the strike price.
Because of market volatility, option writers demand a higher return to compensate them for the greater risk of loss due to a rapidly changing market.
The $6.00 strike price option has extrinsic value of 8 cents, the difference between the premium and the exercise value.
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