If you are bullish on lean hogs, you can profit from a rise in lean hogs price by buying (going long) lean hogs call options.
You observed that the near-month CME Lean Hogs futures contract is trading at the price of USD 0.6015 per pound. A CME Lean Hogs call option with the same expiration month and a nearby strike price of USD 0.6000 is being priced at USD 0.0400/lb. Since each underlying CME Lean Hogs futures contract represents 40000 pounds of lean hogs, the premium you need to pay to own the call option is USD 1,600.
Assuming that by option expiration day, the price of the underlying lean hogs futures has risen by 15% and is now trading at USD 0.6917 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 lean hogs futures at the strike price of USD 0.6000. This means that you get to buy the underlying lean hogs at only USD 0.6000/lb on delivery day.
To take profit, you enter an offsetting short futures position in one contract of the underlying lean hogs futures at the market price of USD 0.6917 per pound, resulting in a gain of USD 0.0917/lb. Since each CME Lean Hogs call option covers 40000 pounds of lean hogs, gain from the long call position is USD 3,668. Deducting the initial premium of USD 1,600 you paid to buy the call option, your net profit from the long call strategy will come to USD 2,068.
|Long Lean Hogs Call Option Strategy|
|Gain from Option Exercise||=||(Market Price of Underlying Futures - Option Strike Price) x Contract Size|
|=||(USD 0.6917/lb - USD 0.6000/lb) x 40000 lb|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Gain from Option Exercise - Investment|
|=||USD 3,668 - USD 1,600|
|Return on Investment||=||129%|
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 lean hogs option sale will be equal to it's intrinsic value.
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