Strike Price vs. Futures Price
Meta Pro Trader Options Education series.
The most important influence on an option’s price is the relationship between the underlying futures price and the option’s strike price.
Depending upon futures prices relative to a given strike price, an options contract is said to be at-the-money, in-the-money, or out-of-the-money. An options contract is at-the-money when the strike price is the closest to the price of the underlying futures contract. For example, if the November crude oil futures price is $25 per barrel, the November $25 call and the November $25 put are the at-the-money-options.
An options contract is considered in-the-money when the price of the futures contract is above a call’s strike price, or when the futures price is below a put’s strike price.
When the October heating oil futures price is 72¢ per gallon, the October 70¢ call is in-the-money. It grants the holder of the options contract the right to buy an October futures contract at 70¢ per gallon even though the market is at 72¢. Therefore, the call is automatically worth at least 2¢ per gallon; and is said to have an intrinsic value of 2¢ per gallon.
A put is in-the-money when the underlying futures price is less than the put’s strike price. If the September gold futures contract is $280 per ounce, a September $290 put is in-the-money. It gives the holder of the options contract the right to sell a futures contract at a price of $290 even though the market is trading at $280, giving the options contract an intrinsic value of $10.
When the December natural gas futures price is $5.50 per million British thermal units, the December $5.65 call is out-of-the-money. It grants the holder of the options contract the right to buy a December futures contract at $5.65 per million Btus even though the market is at $5.50. Therefore, the call has no intrinsic value.
A put is out-of-the-money when the underlying futures price is higher than the put’s strike price. If the March copper futures contract is 76¢ per pound, a March 69¢ per-pound put is out-of-the-money. It gives the holder of the options contract the right to sell a futures contract at a price of 76¢, but since the market is trading at 69¢, it is unlikely the options contract would be exercised since it has no intrinsic value.
An option’s premium will usually equal or exceed whatever intrinsic value the options contract has, if any. For example, if a crude oil options contract is in-the-money by $1 per barrel, its premium will almost always be at least $1.