Heating Oil Option
The futures heating oil price, and the heating
oil option price is not the same thing. Option price valuation is not as straightforward as futures valuation. Option
premium is comprised of intrinsic value and extrinsic value.
An option has intrinsic value if the market is trading above the strike price of a call option, or below the
strike price of a put option. If an option contract has intrinsic value it is called “in the money.” If an option
contract does not have intrinsic value it is called “out of the money.”
If heating oil is trading at $1.40, a $1.35 call option is $.05 in the money so the intrinsic value of the
option is $2,100.
The extrinsic value of the
option is its “time value.” Extrinsic value takes into account the possibility that an option may go in the money
by expiration. The more time that an option has, the more extrinsic value it has. As an option approaches its expiration date
it loses value. This is called time decay. At expiration an option has no extrinsic value so if the option is out of the money
it expires worthless.
Heating oil option prices
do not move in tandem with futures prices. A $.01 move in your favor in the heating oil futures markets does not necessarily
equal to a $.01 increase in the heating oil option value. The amount that an option value will increase based upon an increase
in its futures price is called its delta. Call option deltas are measures from 0 to 1. As an option goes from “out of
the money” to “in the money” its delta increases.
If a heating oil call option has a delta of .5 and the price of the heating oil futures market increases by
$.01 the value of the option will increase by $.005 or $210.
If you are a speculator with a limited amount of risk capital then heating oil options may be best way
for you to invest in the heating oil market.