Buying Gold Call Options to Profit from a Rise in Gold Prices

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

Example: Long Gold Call Option

You observed that the near-month TOCOM Gold futures contract is trading at the price of JPY 2,518 per gram. A TOCOM Gold call option with the same expiration month and a nearby strike price of JPY 2,500 is being priced at JPY 168.00/gm. Since each underlying TOCOM Gold futures contract represents 1000 grams of gold, the premium you need to pay to own the call option is JPY 168,000.

Assuming that by option expiration day, the price of the underlying gold futures has risen by 15% and is now trading at JPY 2,896 per gram. 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 gold futures at the strike price of JPY 2,500. This means that you get to buy the underlying gold at only JPY 2,500/gm on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying gold futures at the market price of JPY 2,896 per gram, resulting in a gain of JPY 396.00/gm. Since each TOCOM Gold call option covers 1000 grams of gold, gain from the long call position is JPY 396,000. Deducting the initial premium of JPY 168,000 you paid to buy the call option, your net profit from the long call strategy will come to JPY 228,000.

Long Gold Call Option Strategy
Gain from Option Exercise=(Market Price of Underlying Futures - Option Strike Price) x Contract Size
=(JPY 2,896/gm - JPY 2,500/gm) x 1000 gm
=JPY 396,000
Investment=Initial Premium Paid
=JPY 168,000
Net Profit=Gain from Option Exercise - Investment
=JPY 396,000 - JPY 168,000
=JPY 228,000
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 gold option sale will be equal to it's intrinsic value.

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