Buying Crude Oil Call Options to Profit from a Rise in Crude Oil Prices

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

Example: Long Crude Oil Call Option

You observed that the near-month NYMEX Light Sweet Crude Oil futures contract is trading at the price of USD 40.30 per barrel. A NYMEX Crude Oil call option with the same expiration month and a nearby strike price of USD 40.00 is being priced at USD 2.6900/barrel. Since each underlying NYMEX Light Sweet Crude Oil futures contract represents 1000 barrels of crude oil, the premium you need to pay to own the call option is USD 2,690.

Assuming that by option expiration day, the price of the underlying crude oil futures has risen by 15% and is now trading at USD 46.34 per barrel. 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 crude oil futures at the strike price of USD 40.00. This means that you get to buy the underlying crude oil at only USD 40.00/barrel on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying crude oil futures at the market price of USD 46.35 per barrel, resulting in a gain of USD 6.3400/barrel. Since each NYMEX Light Sweet Crude Oil call option covers 1000 barrels of crude oil, gain from the long call position is USD 6,340. Deducting the initial premium of USD 2,690 you paid to buy the call option, your net profit from the long call strategy will come to USD 3,650.

Long Crude Oil Call Option Strategy
Gain from Option Exercise=(Market Price of Underlying Futures - Option Strike Price) x Contract Size
=(USD 46.34/barrel - USD 40.00/barrel) x 1000 barrel
=USD 6,340
 
Investment=Initial Premium Paid
=USD 2,690
 
Net Profit=Gain from Option Exercise - Investment
=USD 6,340 - USD 2,690
=USD 3,650
 
Return on Investment=136%

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

Learn More About Crude Oil Futures & Options Trading

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