Prices of options
The price of an option that is freely traded on a commodity exchange fluctuates in response to price changes in the underlying commodity futures contract. The same anonymity exists between an option buyer and an option writer as exists between the buyer and the seller of a commodity futures contract. Like a futures position, an option position may be closed out at any time through simple transference to a third party, via an offsetting transaction made in the options trading pit on the floor of the futures exchange. There are fixed strike prices at which options on futures may be contracted, and each option has a fixed expiry date, preceding the expiry date of the underlying future by up to five weeks. Some actively traded commodities, such as gold, currencies, and the S&P500 stock market index have options expiring every month.
The life of an option is always less than the life of its associated futures contract, with 6 months being about the maximum term. Since an option is traded right up to its moment of expiry, the term to expiry of an option continuously diminishes with the passage of time. It is possible to buy or sell an option with a term to expiry as short as 1 minute.
An option is defined by its strike price and by its date of expiry. For example, the buyer of an August 360 gold call is buying the right to purchase a contract of August gold at $360 per ounce at any time up to and including the moment the option expires (expiry of August gold options is on the second Friday of July). Each listed option is traded independently of all others; for example, an August 360 gold call, and a September 370 gold call are separate and independent options contracts.
The price at which an option trades in the free market will depend upon the strike price of the option, the prevailing price of the futures contract to which the option is attached, the anticipated price variability in that futures contract, and the time remaining until expiry of the option. In the very short term, any increase in the price of a futures contract will result in higher call option values and lower put option values for options on that future. Likewise, any decrease in the price of a futures contract will result in higher put option values and lower call option values. Price variability in a futures contract will be the main determinant of the values that the market will place on its associated options. For this reason, and because there are so many options on each futures contract, price charts are not normally kept for options.
A call option is said to be in-the-money when its underlying future is trading at a price higher than the strike price of the option. An option which is in-the-money has real value even if exercised immediately; in practice, this is rarely done unless the option is so deep in the money that the buyer is willing to sacrifice a small residual option premium in favor of cash. When a call option has no immediate exercise value, it is said to be out-of-the- money, its market value deriving entirely from its potential, that is, the potential for the future to rise above the strike price during the remaining life of the option. Reverse arguments hold for put options. A put option is in-the-money when the futures price is under the strike price. An option with a strike price exactly equal to the futures price is said to be at-the-money and is the option in which trading is likely to be most active. Options are available at strike prices so far out of the money, and with such short times to expiry, that only a massive economic dislocation or a mammoth natural disaster could give them any terminal value. These options can be purchased for as little as $25, and very occasionally,like a lottery ticket, one of them will pay off.
Tags: cash, financial market, funds, futures, mortgage, Options