Buying Gold Put Options to Profit from a Fall in Gold Prices

If you are bearish on gold, you can profit from a fall in gold price by buying (going long) gold put options.

Example: Long Gold Put 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 put 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 1,000 grams of gold, the premium you need to pay to own the put option is JPY 168,000.

Assuming that by option expiration day, the price of the underlying gold futures has fallen by 15% and is now trading at JPY 2,140 per gram. 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 gold futures at the strike price of JPY 2,500. In other words, it also means that you get to sell 1,000 grams of gold at JPY 2,500/gm on delivery day.

To take profit, you enter an offsetting long futures position in one contract of the underlying gold futures at the market price of JPY 2,140 per gram, resulting in a gain of JPY 360.00/gm. Since each TOCOM Gold put option covers 1,000 grams of gold, gain from the long put position is JPY 360,000. Deducting the initial premium of JPY 168,000 you paid to purchase the put option, your net profit from the long put strategy will come to JPY 192,000.

Long Gold Put Option Strategy
Gain from Option Exercise=(Option Strike Price - Market Price of Underlying Futures) x Contract Size
=(JPY 2,500/gm - JPY 2,140/gm) x 1000 gm
=JPY 360,000
Investment=Initial Premium Paid
=JPY 168,000
Net Profit=Gain from Option Exercise - Investment
=JPY 360,000 - JPY 168,000
=JPY 192,000
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 gold option sale will be equal to it's intrinsic value.

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