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Cotton Options

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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.

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Cotton Options

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Commodity trading is not suitable for everyone. The risk of loss in trading can be substantial. This material has been prepared by a sales or trading employee or agent of Van Commodities, Inc. and is, or is in the nature of, a solicitation. This material is not a research report prepared by Van Commodities, Inc. Research Department. Please view our Risk Disclosure.

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