If you are bullish on live cattle, you can profit from a rise in live cattle price by buying (going long) live cattle call options.
You observed that the near-month CME Live Cattle futures contract is trading at the price of USD 0.8445 per pound. A CME Live Cattle call option with the same expiration month and a nearby strike price of USD 0.8400 is being priced at USD 0.0600/lb. Since each underlying CME Live Cattle futures contract represents 40000 pounds of live cattle, the premium you need to pay to own the call option is USD 2,400.
Assuming that by option expiration day, the price of the underlying live cattle futures has risen by 15% and is now trading at USD 0.9712 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 live cattle futures at the strike price of USD 0.8400. This means that you get to buy the underlying live cattle at only USD 0.8400/lb on delivery day.
To take profit, you enter an offsetting short futures position in one contract of the underlying live cattle futures at the market price of USD 0.9712 per pound, resulting in a gain of USD 0.1312/lb. Since each CME Live Cattle call option covers 40000 pounds of live cattle, gain from the long call position is USD 5,248. Deducting the initial premium of USD 2,400 you paid to buy the call option, your net profit from the long call strategy will come to USD 2,848.
|Long Live Cattle Call Option Strategy|
|Gain from Option Exercise||=||(Market Price of Underlying Futures - Option Strike Price) x Contract Size|
|=||(USD 0.9712/lb - USD 0.8400/lb) x 40000 lb|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Gain from Option Exercise - Investment|
|=||USD 5,248 - USD 2,400|
|Return on Investment||=||119%|
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 live cattle option sale will be equal to it's intrinsic value.
To buy or sell futures, you need a broker that can handle futures trades.
OptionsHouse is a full fledged Futures Commission Merchant that provides a streamlined access to the futures markets at extremely reasonable contract rates.Click here to open a futures trading account at OptionsHouse.com now!
Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]
If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]
If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®.... [Read on...]
Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]
As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]
Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]
To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]
Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]
Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]
Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]
In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]
Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]