How Are Futures Options Valued?

Say you bought a futures option in September for £2,000, a month later that same option could be worth £1,800 or even less. Conversely, it could be valued at £2,300 or more. It is vital therefore to have a good grasp of what drives premium prices and when.

A futures option has two values – an intrinsic value and a time value. The premium set for an option on a futures contract is the sum of these two values.

The intrinsic value is the sum of money – if any – that could be realised by exercising the option at its strike price (previously agreed price) and liquidating the acquired futures position at the present price of the futures contract.

The time value is the price willing option buyers are currently prepared to pay. Of course, this is predicated by the option seller being willing to accept what's on offer. The time value - in addition to any intrinsic value – is for the specific rights that a given option conveys. Effectively, the time value is, in gambling terms, the odds on the option increasing in value before it reaches its expiry date.