If you are bullish on ethanol, you can profit from a rise in ethanol price by buying (going long) ethanol call options.
You observed that the near-month CME Ethanol futures contract is trading at the price of USD 1.5800 per gallon. A CME Ethanol call option with the same expiration month and a nearby strike price of USD 1.6000 is being priced at USD 0.1100/gal. Since each underlying CME Ethanol futures contract represents 29000 gallons of ethanol, the premium you need to pay to own the call option is USD 3,190.
Assuming that by option expiration day, the price of the underlying ethanol futures has risen by 15% and is now trading at USD 1.8170 per gallon. 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 ethanol futures at the strike price of USD 1.6000. This means that you get to buy the underlying ethanol at only USD 1.6000/gal on delivery day.
To take profit, you enter an offsetting short futures position in one contract of the underlying ethanol futures at the market price of USD 1.8170 per gallon, resulting in a gain of USD 0.2170/gal. Since each CME Ethanol call option covers 29000 gallons of ethanol, gain from the long call position is USD 6,293. Deducting the initial premium of USD 3,190 you paid to buy the call option, your net profit from the long call strategy will come to USD 3,103.
|Long Ethanol Call Option Strategy|
|Gain from Option Exercise||=||(Market Price of Underlying Futures - Option Strike Price) x Contract Size|
|=||(USD 1.8170/gal - USD 1.6000/gal) x 29000 gal|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Gain from Option Exercise - Investment|
|=||USD 6,293 - USD 3,190|
|Return on Investment||=||97%|
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 ethanol option sale will be equal to it's intrinsic value.
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