Buying Cocoa Put Options to Profit from a Fall in Cocoa Prices
If you are bearish on cocoa, you can profit from a fall in cocoa price by buying (going long) cocoa put options.
Example: Long Cocoa Put 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 put 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 put option is GBP 1,208.
Assuming that by option expiration day, the price of the underlying cocoa futures has fallen by 15% and is now trading at GBP 1,540 per tonne. At this price, your put option is now in the money.
Gain from Put Option Exercise
By exercising your put option now, you get to assume a short position in the underlying cocoa futures at the strike price of GBP 1,800. In other words, it also means that you get to sell 10 tonnes of cocoa at GBP 1,800/ton on delivery day.
To take profit, you enter an offsetting long futures position in one contract of the underlying cocoa futures at the market price of GBP 1,540 per tonne, resulting in a gain of GBP 260.00/ton. Since each Euronext Cocoa put option covers 10 tonnes of cocoa, gain from the long put position is GBP 2,600. Deducting the initial premium of GBP 1,208 you paid to purchase the put option, your net profit from the long put strategy will come to GBP 1,392.
| Long Cocoa Put Option Strategy | ||
| Gain from Option Exercise | = | (Option Strike Price - Market Price of Underlying Futures) x Contract Size |
| = | (GBP 1,800/ton - GBP 1,540/ton) x 10 ton | |
| = | GBP 2,600 | |
| Investment | = | Initial Premium Paid |
| = | GBP 1,208 | |
| Net Profit | = | Gain from Option Exercise - Investment |
| = | GBP 2,600 - GBP 1,208 | |
| = | GBP 1,392 | |
| Return on Investment | = | 115% |
Sell-to-Close Put Option
In practice, there is often no need to exercise the put option to realise the profit. You can close out the position by selling the put 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.
Related Articles
- Cocoa Futures Basics
- Buying Cocoa Futures to Profit from a Rise in Cocoa Prices
- Selling Cocoa Futures to Profit from a Fall in Cocoa Prices
- Cocoa Options Basics
- Cocoa Call Option Trading Basics
- Hedging Against Rising Cocoa Prices with Cocoa Futures
- Hedging Against Falling Cocoa Prices with Cocoa Futures
