Buying Cocoa Call Options to Profit from a Rise in Cocoa Prices

If you are bullish on cocoa, you can profit from a rise in cocoa price by buying (going long) cocoa call options.

Example: Long Cocoa Call Option

You observed that the near-month Euronext Cocoa futures contract is trading at the price of GBP 1,812 per tonne. A Euronext Cocoa call option with the same expiration month and a nearby strike price of GBP 1,800 is being priced at GBP 120.80/ton. Since each underlying Euronext Cocoa futures contract represents 10 tonnes of cocoa, the premium you need to pay to own the call option is GBP 1,208.

Assuming that by option expiration day, the price of the underlying cocoa futures has risen by 15% and is now trading at GBP 2,084 per tonne. At this price, your call option is now in the money.

Gain from Call Option Exercise

By exercising your call option now, you get to assume a long position in the underlying cocoa futures at the strike price of GBP 1,800. This means that you get to buy the underlying cocoa at only GBP 1,800/ton on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying cocoa futures at the market price of GBP 2,084 per tonne, resulting in a gain of GBP 284.00/ton. Since each Euronext Cocoa call option covers 10 tonnes of cocoa, gain from the long call position is GBP 2,840. Deducting the initial premium of GBP 1,208 you paid to buy the call option, your net profit from the long call strategy will come to GBP 1,632.

Long Cocoa Call Option Strategy
Gain from Option Exercise=(Market Price of Underlying Futures - Option Strike Price) x Contract Size
=(GBP 2,084/ton - GBP 1,800/ton) x 10 ton
=GBP 2,840
Investment=Initial Premium Paid
=GBP 1,208
Net Profit=Gain from Option Exercise - Investment
=GBP 2,840 - GBP 1,208
=GBP 1,632
Return on Investment=135%

Sell-to-Close Call Option

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 cocoa option sale will be equal to it's intrinsic value.

Learn More About Cocoa Futures & Options Trading

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