If you are bullish on aluminum, you can profit from a rise in aluminum price by buying (going long) aluminum call options.
You observed that the near-month LME Aluminum futures contract is trading at the price of USD 1,470 per tonne. A LME Aluminum call option with the same expiration month and a nearby strike price of USD 1,500 is being priced at USD 98.00/ton. Since each underlying LME Aluminum futures contract represents 25 tonnes of aluminum, the premium you need to pay to own the call option is USD 2,450.
Assuming that by option expiration day, the price of the underlying aluminum futures has risen by 15% and is now trading at USD 1,690 per tonne. At this price, your call option is now in the money.
By exercising your call option now, you get to assume a long position in the underlying aluminum futures at the strike price of USD 1,500. This means that you get to buy the underlying aluminum at only USD 1,500/ton on delivery day.
To take profit, you enter an offsetting short futures position in one contract of the underlying aluminum futures at the market price of USD 1,691 per tonne, resulting in a gain of USD 190.00/ton. Since each LME Aluminum call option covers 25 tonnes of aluminum, gain from the long call position is USD 4,750. Deducting the initial premium of USD 2,450 you paid to buy the call option, your net profit from the long call strategy will come to USD 2,300.
|Long Aluminum Call Option Strategy|
|Gain from Option Exercise||=||(Market Price of Underlying Futures - Option Strike Price) x Contract Size|
|=||(USD 1,690/ton - USD 1,500/ton) x 25 ton|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Gain from Option Exercise - Investment|
|=||USD 4,750 - USD 2,450|
|Return on Investment||=||94%|
In practice, there is often no need to exercise the call option to realise the profit. You can close out the position by selling the call option in the options market via a sell-to-close transaction. Proceeds from the option sale will also include any remaining time value if there is still some time left before the option expires.
In the example above, since the sale is performed on option expiration day, there is virtually no time value left. The amount you will receive from the aluminum option sale will be equal to it's intrinsic value.
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