If you are bearish on heating oil, you can profit from a fall in heating oil price by buying (going long) heating oil put options.
You observed that the near-month NYMEX Heating Oil futures contract is trading at the price of USD 1.4777 per gallon. A NYMEX Heating Oil put option with the same expiration month and a nearby strike price of USD 1.5000 is being priced at USD 0.1000/gal. Since each underlying NYMEX Heating Oil futures contract represents 42,000 gallons of heating oil, the premium you need to pay to own the put option is USD 4,200.
Assuming that by option expiration day, the price of the underlying heating oil futures has fallen by 15% and is now trading at USD 1.2560 per gallon. At this price, your put option is now in the money.
By exercising your put option now, you get to assume a short position in the underlying heating oil futures at the strike price of USD 1.5000. In other words, it also means that you get to sell 42,000 gallons of heating oil at USD 1.5000/gal on delivery day.
To take profit, you enter an offsetting long futures position in one contract of the underlying heating oil futures at the market price of USD 1.2560 per gallon, resulting in a gain of USD 0.2440/gal. Since each NYMEX Heating Oil put option covers 42,000 gallons of heating oil, gain from the long put position is USD 10,248. Deducting the initial premium of USD 4,200 you paid to purchase the put option, your net profit from the long put strategy will come to USD 6,048.
|Long Heating Oil Put Option Strategy|
|Gain from Option Exercise||=||(Option Strike Price - Market Price of Underlying Futures) x Contract Size|
|=||(USD 1.5000/gal - USD 1.2560/gal) x 42000 gal|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Gain from Option Exercise - Investment|
|=||USD 10,248 - USD 4,200|
|Return on Investment||=||144%|
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 heating oil option sale will be equal to it's intrinsic value.
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