Dairy Futures and Options Tutorial

Factors Affecting Total Premium Levels

Oftentimes, even though the strike price of an option equals the current settle price of the underlying futures contact, there continues to be a positive premium associated with that option. As noted previously, this is due to the fact that an options premium is determined not only by its intrinsic value but also by what is referred to the time value of the contract. The time value is related to the volatility of the settle prices for the underlying contract, the time until expiration and interest rates. With more time remaining until the underlying futures contracts expires, there is a greater chance that the futures market will move such that the option will be in-the-money. The time value component of the premium diminishes as the maturity date for the option approaches. Highly volatile markets are risky markets and the premium must be large enough to entice traders to offer options for sale. The more volatile the market the higher the premium. Below you can see how your options premium is determined. First, identify the month, dairy product and type of option. Then enter a current settle price for the underlying futures contract. Third, enter three alternative strike prices. This results in calculated intrinsic values being displayed. You then enter your best guess as to the options Time value. The last row of the this table shows the total premium for this contract. Note what happens if you change the settle price, strike price or time value.

Intrinsic Value + Time Value = Total Premium


Assume you are purchasing a option.
Futures Settle Price  
Alternative Strike Prices
Intrinsic Value 0.00 0.00 0.00
+ Time Value 0.00 0.00
= Total Premium 0.00 0.00 0.00