In a previous article, I explained commodity option expiration, exercising, and assignment. I noted a long (purchased) option position (call or put) has the right to exercise the contract. To make an informed decision, I will explain the result of exercising an option contract.
A commodity option contract is a decaying asset that will expire. As an option contract draws near its expiration date, set by the exchanges, both the time value and intrinsic value diminish. Time value is premium in relation to days until expiration. Intrinsic value is the premium in relation to the strike price’s distance from underlying futures contract price. Note that volatility will also play a role in the calculated premium price. The exception to intrinsic value diminishing is an in-the-money contract. At that point, the intrinsic value is a one-to-one ratio of the strike price in relation to the underlying futures contract. For example, a long April 2013 Gold 1600 call will be valued at 50 points (or $5,000) if futures are at 1650.0 on option expiration (March 25, 2013). On the other hand, if futures are at 1600.0 or below on expiration, the option contract is valued at zero. An in-the-money contract, before expiration, will also have time value included in the premium price. However, because there are a number of finite days until expiration, the time value diminishes from day one. Continue reading "To Exercise, Or Not To Exercise (Options), That Is The Question"
