Put options: time value versus intrinsic value

Editor’s Note: This is a continuation of weekly articles on the use of put options on commodity futures as a primary marketing tool to set a minimum price or as a price “booster” for futures contracts. term or HTA contracts.

The final article discusses the process of maximizing revenue from selling a put option, which this article is based on.

Since the value of put options increases as the price of the futures contract decreases, the first objective for maximizing put income is to sell the put option when the price of the underlying futures contract is as low as possible. This is much easier than picking the top, as commodity prices typically spend one to three months near the bottom, but only one to four days near the top.

The last issue of this series was written on August 4. Here is the value of options on August 4, which we have been tracking since early April. September futures were at $7.68:

Here is the current information in the early morning of August 18with September wheat at $7.43:

Map of Wright 1 081822.png

These three options all have the same time value of one cent this morning. This is because there is very little doubt that they will be in-the-money on expiry day August 26th. Two weeks ago there was more doubt, and that’s why the time value was a bit higher.

The September futures price is down 23 cents over the past two weeks. The $9 put option rose in value by about 19 cents, as it lost 6¼ cents in time value while gaining in intrinsic value. The $10 sell value gained 23 cents even though it lost 3½ cents in time value and the $11 sell gained almost 22 cents because it lost 3¼ cents in time value.

Of course, with the futures price down more than 22 cents, the gain in the intrinsic value of the options more than compensated for the loss in time value. Note, however, that September wheat traded at $8.20¾ on August 11, 77 cents higher than it is this morning!

Of those three puts, that was over $3,800 in value per 5,000 bushel option. The good news is that commodity futures usually trade sideways near the bottom for one to three months. It is therefore much easier to choose a price to sell the put option than to choose a price to sell a call. Take a look at the September wheat daily price chart on the morning of August 18:

August 18 Daily Wheat Price Chart.png

I like the length of time available to select a reasonably near-low futures price to sell the put options. These options have one week of life remaining. The futures price could drop another dollar; it could also rally a dollar. This is a potential $10,000 swing, but futures will likely continue their sideways range into August.

Entering the available price this morning, the $9.00 put was worth $7,900. Dan and Joe, our two sample farmers, paid $1,450 for the $9.00 stake. The $10 bet is worth $12,900. Dan and Joe bought it for $1,450 after wheat rallied back a dollar after buying the $9 put option. Don and Junior bought the $10 put option for $2,950, so they have $9,950 in profit. After wheat futures gained another dollar, they bought the $11 put at the same price as the $10 put, or $2,950. The $11 put option is now worth $17,900, a nice profit of $14,950 on an option, or 5,000 bushels.

To sell or not to sell this morning? That is the question for mis wheat owners. These are the lowest September futures since Jan. 18, but $7.43 is a historically high price for wheat. Ukraine is now exporting wheat and Russia, the world’s largest wheat exporter, is harvesting its biggest wheat crop ever.

Next week will be the expiry day. We see how these put options work.

This is part 17 of a series. To learn more, read:

Part 1: Put options add value to your grain cash sales

Part Two: Protect Your Crops Without Margin Calls

Part Three: Improving Profit Opportunities with Put Options

Part Four: Put Options and No Margin Calls

Part Five: When Does a Put Have No Potential Value?

Part Six: Why Are Put Options So Expensive?

Part Seven: Using Put Options to Manage Grain Marketing Risk

Part 8: What is the time value of an option?

Part Nine: How to Calculate the Time Value of an Option

Part 10: Using Put Options with Hedge-to-Arrive to Increase Farm Income

Part 11: Sample Timeline to Explain How Wheat Works

Part 12: Put options complement futures contracts

Part 13: Put Options: Understanding Premium and Delta

Part 14: Find the best combination of marketing tools

Part 15: How to Liquidate the Put Option for Optimal Value

Part 16: Maximizing revenue from writing put options

Wright is an Ohio-based grain marketing consultant. Contact him at (937) 605-1061 or [email protected]. For more information, visit www.wrightonthemarket.com.

No one associated with Wright on the Market is a cash grain broker or a futures broker. All information presented is researched and believed to be true and correct, but nothing is 100% in this business.

The opinions of the author are not necessarily those of Farm Futures or Farm Progress.

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