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The Basics of Options
By: Rick Thachuk   Wednesday, August 8, 2007 11:30 PM
This is determined by the futures exchange and detailed in the option contract specifications.) For instance, consider the example above of a June Deutschemark call option having a strike price of $0.6355. The price of this option might be quoted as $0.0028, or .28 cents, or just 28, which means 28 ticks. Each tick of a Deutschemark options contract (as well as a futures contract) has value of $12.50. Therefore, the dollar price of this option is 28x$12.50 = $350.

Valuing Call and Put Options
Call and put option premiums depend upon several factors, the most important of which is the strike price of the option relative to the market price of the underlying futures contract. A call option becomes more valuable, and hence the premium becomes greater, as the market price of the underlying futures contract rises above the option's strike price. Consider the example above of a June Deutschemark call option having a strike price of $0.6355. If the market price of a June Deutschemark futures contract is $0.6295, then this option will have little value: Why pay for the privilege of buying the futures at $0.6355 when you can alternatively buy the futures now in the market at a lower price? Say, though, that the market price of a June Deutschemark futures is $0.6385. Now, the option should have value because, if you own it, you can purchase the futures at $0.6355 which is below the market price. In fact, this option will cost at least $0.0030 (having dollar value of $375), which is the difference between the strike price of the option and the market price of the underlying futures contract and is referred to as the instrinsic value of the option. The option will likely trade at a price above its instrinsic value, say, $0.0041 (having dollar value of $512.50). The amount by which an option trades above its intrinsic value is referred to as the option's time value. In this case, the time value is 11 ticks having value of $137.50.

A put option becomes more valuable, and hence the premium becomes greater, as the market price of the underlying futures contract falls below the option's strike price. Consider again the example of a June Deutschemark put option having a strike price of $0.6395. If the market price of a June Deutschemark futures contract is $0.6430, then this option will have little value: Why pay for the privilege of selling the futures at $0.6395 when you can alternatively sell the futures now in the market at a higher price? Say, though, that the market price of a June Deutschemark futures is $0.6340. Now, the option should have value because, if you own it, you can sell the futures at $0.6395 which is above the market price. In fact, this option will cost at least $0.0055 (having dollar value of $687.50), which is the difference between the strike price of the option and the market price of the underlying futures contract - the instrinsic value of the option.


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