Buying Crude Oil Put Options to Profit from a Fall in Crude Oil Prices
If you are bearish on crude oil, you can profit from a fall in crude oil price by buying (going long) crude oil put options.
Example: Long Crude Oil Put 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 put 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 1,000 barrels of crude oil, the premium you need to pay to own the put option is USD 2,690.
Assuming that by option expiration day, the price of the underlying crude oil futures has fallen by 15% and is now trading at USD 34.25 per barrel. 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 crude oil futures at the strike price of USD 40.00. In other words, it also means that you get to sell 1,000 barrels of crude oil at USD 40.00/barrel on delivery day.
To take profit, you enter an offsetting long futures position in one contract of the underlying crude oil futures at the market price of USD 34.26 per barrel, resulting in a gain of USD 5.7500/barrel. Since each NYMEX Light Sweet Crude Oil put option covers 1,000 barrels of crude oil, gain from the long put position is USD 5,750. Deducting the initial premium of USD 2,690 you paid to purchase the put option, your net profit from the long put strategy will come to USD 3,060.
| Long Crude Oil Put Option Strategy | ||
| Gain from Option Exercise | = | (Option Strike Price - Market Price of Underlying Futures) x Contract Size |
| = | (USD 40.00/barrel - USD 34.25/barrel) x 1000 barrel | |
| = | USD 5,750 | |
| Investment | = | Initial Premium Paid |
| = | USD 2,690 | |
| Net Profit | = | Gain from Option Exercise - Investment |
| = | USD 5,750 - USD 2,690 | |
| = | USD 3,060 | |
| Return on Investment | = | 114% |
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 crude oil option sale will be equal to it's intrinsic value.
Related Articles
- Crude Oil Futures Basics
- Buying Crude Oil Futures to Profit from a Rise in Crude Oil Prices
- Selling Crude Oil Futures to Profit from a Fall in Crude Oil Prices
- Crude Oil Options Basics
- Crude Oil Call Option Trading Basics
- Hedging Against Rising Crude Oil Prices with Crude Oil Futures
- Hedging Against Falling Crude Oil Prices with Crude Oil Futures
