The
futures lumber price, and the lumber 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 an option contract has intrinsic value it is called “in the money.” If an option contract does not have intrinsic
value it is called “out of the money.”
For example:
If lumber is trading
at $200 a $195 call option is $5 in the money so the intrinsic value of the option is $550.
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 an option has the more extrinsic value it has. As an option approaches
its expiration date is looses value. This is called time decay. At expiration an option has no extrinsic value so if the option
is out of the money it expires worthless.
Lumber option prices do not move in tandem with futures prices.
A $1 move in your favor in the lumber futures markets does not necessarily equal to a $1 increase in the lumber option
value. The amount that a option value will increase based upon an increase in its futures price is called its delta. Call
option deltas are measures from 0 to 1. As an option goes from “out of the money” to “in the money”
its delta increases.
For example:
If a lumber call option has a delta of .5 and the price of the lumber
futures market increases by $1 the value of the option will increase by $.5 or $55.
If you are a speculator
with a limited amount of risk capital then lumber options may be best way for you to invest in the lumber market.
