If you are bullish on feeder cattle, you can profit from a rise in feeder cattle price by buying (going long) feeder cattle call options.
You observed that the near-month CME Feeder Cattle futures contract is trading at the price of USD 0.9520 per pound. A CME Feeder Cattle call option with the same expiration month and a nearby strike price of USD 0.9500 is being priced at USD 0.0600/lb. Since each underlying CME Feeder Cattle futures contract represents 50000 pounds of feeder cattle, the premium you need to pay to own the call option is USD 3,000.
Assuming that by option expiration day, the price of the underlying feeder cattle futures has risen by 15% and is now trading at USD 1.0950 per pound. 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 feeder cattle futures at the strike price of USD 0.9500. This means that you get to buy the underlying feeder cattle at only USD 0.9500/lb on delivery day.
To take profit, you enter an offsetting short futures position in one contract of the underlying feeder cattle futures at the market price of USD 1.0948 per pound, resulting in a gain of USD 0.1450/lb. Since each CME Feeder Cattle call option covers 50000 pounds of feeder cattle, gain from the long call position is USD 7,250. Deducting the initial premium of USD 3,000 you paid to buy the call option, your net profit from the long call strategy will come to USD 4,250.
|Long Feeder Cattle Call Option Strategy|
|Gain from Option Exercise||=||(Market Price of Underlying Futures - Option Strike Price) x Contract Size|
|=||(USD 1.0950/lb - USD 0.9500/lb) x 50000 lb|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Gain from Option Exercise - Investment|
|=||USD 7,250 - USD 3,000|
|Return on Investment||=||142%|
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 feeder cattle option sale will be equal to it's intrinsic value.
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