How do Commodity Options Work?
How is the value of an option figured out? First you have to understand the meaning of intrinsic and extrinsic. The option premium is made up of both of these values. Intrinsic is the value of the option if you exercised it to the futures contract and then offset it. For example if you have a Nov. $5 soybean call and the futures price for that contract is $5.20 hence there is a .20 intrinsic value for that option. Soybeans are a 5000 bushel contract so 20 cents multiplied by 5000= $1000 intrinsic value for that option. Now let’s say that same $5 Nov. soybean call costs $1600 in premium. $1000 of the cost is intrinsic value and the other $600 is extrinsic. Extrinsic value is made up of time value, volatility premium and demand for that specific option. If the option has 60 days left until expiration it has more time value than it would with 45 days left. If the market has large price movements from low to high the volatility premium will be higher than a small price movement market. If
