Put Options Lesson 9: Time Value Calculation

How to Calculate Time Value of an Option

The last put discussion ended with the question, “Was the $11 September wheat put out-of-the-money or in-the-money on the close of business Monday, April 25th with September wheat at $10.71¼?”

To determine if the $11 put was in-the-money or out-of-the-money, you ask yourself:

If that put option is exercised (exchanged for futures position), would the resulting futures position have a profit or a loss?

1. A put with a strike price of $11.00, if exercised, would be a short (sold) position at the strike price of $11.00.

2. If the futures price was $10.71¼, would a short (sold) position at $11.00 have a profit?

3. Yes! Sold at $11.00 and the market is at $10.71¼ = 28¾¢ profit.

What was paid for the option or what the option is presently worth has nothing to do with the determination whether the option is in-the-money or out-of-the-money. The only facts that matter are the strike price of the option and the price of the underlying futures contract.

The in-the-money value of an option is also called intrinsic value. Since the $11.00 put option was 28¾¢ in-the-money, the option has to be worth at least 28¾¢, even if it was expiration day. But the September options do not expire until August 26th, so it must also have time value. How much of the $11.00 put option’s premium is time value?

The premium of the September $11.00 put on the close Monday was an even 90¢. The time value of an in-the-money option is:

Premium minus intrinsic value = time value.

So, for $11.00 September wheat put on Monday time value would be calculated as follows:

Premium (value) of 90¢ minus 28¾¢ in-the-money (aka intrinsic value) = 61¼¢ of time value.

The time value of an option’s premium is determined by how much time remains in the life of that option and the volatility of the futures contract. It is easy to understand that if the futures contract is moving 15 to 35¢ up and down most days, it is more difficult to assess its price projection for the next many days, weeks and especially months. Therefore, that difficulty of projecting the price projection means the option will cost more, regardless of whether it has any intrinsic value or not.

When the futures are quiet and moving in a relatively consistent trend, the volatility factor is diminished and that reduces the time value of an option.

Today (April 26, 2022), September CBOT wheat was up 21¼¢. The put options values should have decreased. The $10 put did move from 53 1/8¢ on Monday to 46 7/8¢ today, down 6¼¢. The delta indicates the premium should have declined 7¼¢. Nothing is 100% in this business.

A trader with a short September futures contract lost $1,062.50 (21¼¢ times 5,000 bushels per futures contract); a trader with the $10 put lost $362.50 (6¼¢ times 5,000 bushels per option contract). When the market futures price moves against you, one loves to hold options rather than futures.

Below are the settlement prices and deltas of some of the September 2022 CBOT wheat puts for April 25th, 2022: