Cotton Option Price
The
futures cotton price, and the cotton option price is not the same thing. Option price valuation is not as straightforward
as futures valuation. Option premium is comprised of intrinsic value and extrinsic value.
An
option has intrinsic value if the market is trading above the strike price of a call option, or below the strike price of
a put option. If a option contract has intrinsic value it is called “in the money.” If a option contact does not
have intrinsic value it is called “out of the money.”
For example:
If cotton is trading at $.83 a $.80 call option is $.03 in the money so the intrinsic value of the
option is $1,500.
The extrinsic value of the option is its “time value.”
Extrinsic value takes into account the possibility that an option may go in the money by expiration. The more time that a
option has the more extrinsic value it has. As a option approaches it expiration date is looses value. This is called time
decay. At expiration a option has no extrinsic value so if the option is out of the money it expires worthless.
Cotton option prices do not move in tandem with futures prices. A $.01 move in your favor in the
cotton futures markets does not necessarily equal to a $.01 increase in the cotton option value. The amount that a option
value will increase based upon a increase in its futures price is called its delta. Call option deltas are measures from 0
to 1. As a option goes from “out of the money” to “in the money” its delta increases.
For example:
If a cotton call option has a delta
of .5 and the price of the cotton futures market increases by $.01 the value of the option will increase by $.005 or $250.
If you are a speculator with a limited amount of risk capital then cotton options may be best way
for you to invest in the cotton market.
