Quick Answer
An option's premium always equals intrinsic value plus time value. A call's intrinsic value is the futures price minus the strike; a put's is the strike minus the futures price, and neither can go below zero. Time value decays to zero by expiration and peaks at-the-money. Delta measures how much the premium moves for a one-unit move in the underlying.
The whole unit on one sheet: how a premium splits into intrinsic and time value, what delta measures, and how to turn a quoted premium into dollars.
What Splits an Option's Premium Into Two Parts?
- These are options on futures, so a call is the right to go long futures at the strike, and a put is the right to go short futures at the strike.
- The core identity: Premium = Intrinsic Value + Time Value.
- Intrinsic value is the in-the-money amount, and it can never be negative. Time value (extrinsic value) is whatever the buyer pays above that, the price of the chance the option gains more intrinsic value before expiration.
- Only an in-the-money (ITM) option splits its premium across both parts. An at-the-money (ATM) or out-of-the-money (OTM) option has zero intrinsic value, so its entire premium is time value.
Which Numbers Matter Most?
| Concept | Formula or Fact |
|---|---|
| Call intrinsic value | max(0, futures price minus strike) |
| Put intrinsic value | max(0, strike minus futures price) |
| Time value | Premium minus intrinsic value |
| At expiration | Time value equals zero, so premium equals intrinsic value |
| Time value peak | Greatest at-the-money, not deep in-the-money |
| Call delta | Positive, about 0 to +1 |
| Put delta | Negative, about 0 to minus 1 |
| At-the-money delta | Roughly 0.5 in absolute value |
| Dollar cost of an option | Quoted premium multiplied by the contract's point value (multiplier) |
How Does Delta Work as a Hedge Ratio?
- Delta approximates the hedge ratio: how many futures contracts an option position behaves like.
- An underlying futures contract has a delta of 1. An option with a delta of 0.5 behaves like half a futures contract, so it takes roughly two such options to equal one futures contract.
- Because delta shifts as the underlying moves, the hedge ratio is dynamic, not fixed for the life of the trade.
How Do You Read a Premium Quote?
- A premium is quoted in the price points and ticks of the underlying futures, not directly in dollars.
- Dollar cost equals the quoted premium multiplied by the contract's point value (multiplier), which is set by the exchange and varies by contract.
Which Gotchas Trip Students Up?
- The call and put intrinsic-value formulas are mirror images and the most-flipped fact in the unit. Call equals futures minus strike; put equals strike minus futures. Using "futures minus strike" for a put has it backwards.
- Intrinsic value can never be negative. A negative result just means the option is out-of-the-money and intrinsic value is zero.
- Time value is largest at-the-money, not deep in-the-money. A rich premium on a deep in-the-money option is rich because of intrinsic value, not time value.
- Put delta is negative. Treating every delta as positive is a frequent trap.
- A quoted premium is not a dollar amount until multiplied by the point value, which differs from one futures contract to the next.
Memory Aid: Call wants futures to Climb above the strike (futures minus strike); a put wants them to plunge below it (strike minus futures).
One-Breath Recap
An option's premium always equals intrinsic value plus time value, where a call's intrinsic value is the futures price minus the strike and a put's is the strike minus the futures price, neither ever falling below zero; time value, the price of waiting for more intrinsic value, decays to zero by expiration and peaks at-the-money rather than deep in-the-money; delta measures how much the premium moves for a one-unit move in the underlying, running about 0 to plus 1 for a call and 0 to minus 1 for a put, and it doubles as a dynamic hedge ratio; a quoted premium becomes a dollar cost only after multiplying by the contract's own point value.
Need more than the recap? Read the full Options Premiums unit.