Tag: intrinsic value

Traders Toolbox: Learning Options Part 1 of 4

Posted on by The INO.com Team

There are four components to an options price: underlying contract price, intrinsic value ( determined by strike price), time value (time remaining until expiration) and volatility. (A fifth element, interest rates, also can affect option prices, but for our purposes is unimportant.)

Intrinsic value refers to the amount an option is in-the-money. For example, with Eurodollar futures at 95.55, a 95.00 call has an intrinsic value of .55. The more an option is in the money, the greater its intrinsic value. At-the-money and out-of-the-money options have no intrinsic value.

Options are referred to as "wasting" assets because their value decreases over time until it reaches zero at expiration, a process called time decay. Time value refers to the part of an option's price that reflects the time left until expiration. The more distance an option's expiration date, the greater the premium because of the uncertainty of projecting prices further into the future.

Considering two equivalent call options. Let's say for example, that with May corn futures at 232 1/4, July corn futures at 236 1/4 and 10 days left until May corn options expire, a May 230 call might cost 2 3/8 while a July 234 call costs 6 1/2, even though they are equally in-the-money.

Volatility, perhaps the most important and most widely ignored aspect of options, refers tot he range and rate of price movement of the underlying contract. The "choppier" the market, the higher the price that will be paid for this unstability in the form of higher option premiums.

Volatility usually is expressed as a percentage, and is comparable to the standard deviation of a contract. Higher volatility means higher premiums. Lower volatility means lower premiums. A trader familiar with the volatility history of a contract can gauge whether volatility at a given time is relatively high or low, and can profit from fluctuations in volatility that will in turn increase or decrease option premium.

The Black-Scholes price model, first introduced by Fischer Black and Myron Scholes in 1973, is the most popular theoretical options pricing model largely because it was the first relatively straightforward arithmetic method for determining a fair value for options.

Part 2 will be posted tomorrow, so stay tuned!

Best,
The MarketClub Team

Traders Toolbox: Learning Options Part 1 of 4 Revisited...

Posted on by lindsay

Trader's Toolbox

At MarketClub our mission is to help you become a better trader. Our passion is creating superior trading tools to help you achieve your goals -- no matter which way the markets move -- with objective and unbiased recommendations not available from brokers.

The Trader's Toolbox posts are just another free resource from MarketClub.

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Options Part 1 of 4

"There are four components to an options price: underlying contract price, intrinsic value ( determined by strike price), time value (time remaining until expiration) and volatility. (A fifth element, interest rates, also can affect option prices, but for our purposes is unimportant.)Intrinsic value refers to the amount an option is in-the-money. With Eurodollar futures at 95.55, a 95.00 call has an intrinsic value of .55. The more an option is in the money, the greater its intrinsic value. At-the-money and out-of-the-money options have no intrinsic value.

Options are referred to as “wasting” assets because their value decreases over time until it reaches zero at expiration, a process called time decay. Time value refers to the part of an option’s price that reflects the time left until expiration. The more distance an option’s expiration date, the greater the premium because of the uncertainty of projecting prices further into the future..."

Revisit the Trader's Toolbox Post: "Learning Options Part 1 of 4" here.

Traders Toolbox: Learning Options Part 1 of 4

Posted on by lindsay

There are four components to an options price: underlying contract price, intrinsic value ( determined by strike price), time value (time remaining until expiration) and volatility. (A fifth element, interest rates, also can affect option prices, but for our purposes is unimportant.)

Intrinsic value refers to the amount an option is in-the-money. With Eurodollar futures at 95.55, a 95.00 call has an intrinsic value of .55. The more an option is in the money, the greater its intrinsic value. At-the-money and out-of-the-money options have no intrinsic value.

Options are referred to as "wasting" assets because their value decreases over time until it reaches zero at expiration, a process called time decay. Time value refers to the part of an option's price that reflects the time left until expiration. The more distance an option's expiration date, the greater the premium because of the uncertainty of projecting prices further into the future.

Considering two equivalent call options. With May corn futures at 232 1/4, July corn futures at 236 1/4 and 10 days left until May corn options expire, a May 230 call might cost 2 3/8 while a July 234 call costs 6 1/2, even though they are equally in-the-money.

Volatility, perhaps the most important and most widely ignored aspect of options, refers tot he range and rate of price movement of the underlying contract. The "choppier" the market, the higher the price that will be paid for this unstability in the form of higher option premiums.

Volatility usually is expressed as a percentage, and is comparable to the standard deviation of a contract. Higher volatility means higher premiums. Lower volatility means lower premiums. A trader familiar with the volatility history of a contract can gauge whether volatility at a given time is relatively high or low, and can profit from fluctuations in volatility that will in turn increase or decrease option premium.

The Black-Scholes price model, first introduced by Fischer Black and Myron Scholes in 1973, is the most popular theoretical options pricing model largely because it was the first relatively straightforward arithmetic method for determining a fair value for options.

Part 2 Will Be Posted On November 10th, 2008. So come back soon!

Trader Toolbox: Learning Options Part 1 of 5

Posted on by lindsay

Options on futures have come of age. In fact, at some exchanges, options trading outstrips growth in futures trading by a 2:1 margin. But this growth has a major flaw: Many people use options for the wrong reasons. Sound options trading begins with understanding basic concepts and dispelling common misconceptions about he potential benefits and limitations of these instruments.

The Basics - An option contract gives you the right to buy or sell something at a set price for a limited amount of time or at a specific future date. Options are common in many businesses, such as real estate, where an investor might purchase an option that will give him the right to buy a parcel of land at an agreed upon price for a six-month period, regardless of fluctuations in the market price of the land.

Options on futures are no different. A trader can buy an option in June allowing him to buy December T-bond futures at 100.00, even if the market price in December is 105,00. The buyer pays a price for this opportunity, called the premium. The option buyer is sometimes called the writer.

There are two kinds of options: calls and puts. A call option gives the owner the right to buy futures at a specific price; a put option gives the owner the right to sell futures at the specific price. This predetermined price is called the exercise price, or strike price. A call option owner who "exercises" his right becomes long futures, while an option seller is "assigned" a short futures position. When a trader sells an option, he risks having a losing futures position at any time. In return for assuming this risk, he receives the option premium.

The owner, on the other hand, is under no obligation to exercise, and may sell the option or hold it through the term of the agreement. The last day a buyer can exercise an option is called the expiration date, which is established by the exchange. For example, the owner of a March 445 S&P call call buy March S&P futures at 445.00 until March 17, if he so chooses. The option expires at the end of trading on this day.

Most listed options in the United States are American style options, which allow the holder to exercise any time up through expiration day. European style options can be exercised on expiration day only.

Ins and Outs - The strike price of an option can be described three ways:

In-The-Money refers to calls with strikes prices below the current market price of the underlying future and puts with strike prices above the market price. If coffee futures are trading at 195.00. a 194.00 call is in-the-money, as is a 196.00 put.

At-The-Money options are calls and puts with strike prices equal to the current futures price. If coffee is 197.00, both 197.00 coffee calls and puts are at-the-money.

Out-Of-The-Money refers to calls with strike prices above the current futures price, and puts with strike prices below the future price. With coffee at 194.00, a 195.00 call and a 193.00 put would both be out-of-the-money.

With March bonds at 100.22, the owner of a March 98.00 call could exercise his option, become long bond futures at 98.00, sell the futures at 98.00, sell the futures and make 2.22. If the trader paid less than 2.22 for the opions, he would make a profit on the trade.

Because option buyers are not required to exercise, their market exposure is limited to the premium paid for the option. For sellers, however, risk is equivalent to an outright futures contract, because they can be assigned a futures position at any time.