Options have what is referred to as “time decay.” All this means is that as time goes forward all options lose time value. Remember one of the things that make up the value of an option is how much time it has until expiration. This can be a major part of the price you have to pay. Like they say, “time is money,”, especially in options.

Let’s use an example of buying a Call option in Sugar and we will say that Sugar is currently trading at about 12.00 cents. We are Bullish the market and think that sugar will go to 14.00 in the next couple of months. Let’s also say the front month in the futures market is the March contract.

In the following chart, figure 1.2, you can see the cost (premium) of a 14.00 Call is $134.40 and gives you the right to be long sugar from 14.00. Since Sugar is trading below the strike price then the entire premium is for extrinsic, or time value. Since it is “out-of-the-money” (above the strike price) it has no intrinsic or real money value.

The person who is selling this option is betting that Sugar will not go to 14.00 in the next 53 days and that this option will expire worthless. Actually, it would have to go a little higher than 14.00 for him to lose money since he collected a premium for selling it. So, the option seller’s breakeven is 14.00 plus what he collected in premium. We will talk much more about this later on. For taking this risk, he wants to be paid $134.00. So, these 53 days of time value will cost you $134.00. Options usually expire about 30 days before the futures contract expires.

Now, what if you wanted more time thinking that sugar will indeed go up to 14.00 cents, but it might take longer than 53 days? Well, you will have to buy an option in a further out contract month. Look at Figure 1.3 which is the May contract, the next contract month out.

The May contract with a strike price of 14.00 costs almost twice as much ($257.50) as the March contract with a 14.00 strike price. The reason is the May option has 97 trading days until expiration whereas the March option only has 53 trading days until it expires. Again, time is money, and the option seller wants more money because he is taking a greater risk by giving you more time. The additional risk he is taking is that he is selling you an option with 97 days left rather than 53 days left until the option expires