If you are bearish on lead, you can profit from a fall in lead price by buying (going long) lead put options.
You observed that the near-month LME Lead futures contract is trading at the price of USD 1,145 per tonne. A LME Lead put option with the same expiration month and a nearby strike price of USD 1,100 is being priced at USD 76.33/ton. Since each underlying LME Lead futures contract represents 25 tonnes of lead, the premium you need to pay to own the put option is USD 1,908.
Assuming that by option expiration day, the price of the underlying lead futures has fallen by 15% and is now trading at USD 973.20 per tonne. 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 lead futures at the strike price of USD 1,100. In other words, it also means that you get to sell 25 tonnes of lead at USD 1,100/ton on delivery day.
To take profit, you enter an offsetting long futures position in one contract of the underlying lead futures at the market price of USD 973.25 per tonne, resulting in a gain of USD 126.80/ton. Since each LME Lead put option covers 25 tonnes of lead, gain from the long put position is USD 3,170. Deducting the initial premium of USD 1,908 you paid to purchase the put option, your net profit from the long put strategy will come to USD 1,262.
|Long Lead Put Option Strategy|
|Gain from Option Exercise||=||(Option Strike Price - Market Price of Underlying Futures) x Contract Size|
|=||(USD 1,100/ton - USD 973.20/ton) x 25 ton|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Gain from Option Exercise - Investment|
|=||USD 3,170 - USD 1,908|
|Return on Investment||=||66%|
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 lead option sale will be equal to it's intrinsic value.
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