Buying Live Cattle Call Options to Profit from a Rise in Live Cattle Prices

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.

Example: Long Live Cattle Call Option

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.

Gain from Call Option Exercise

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
=USD 5,248
 
Investment=Initial Premium Paid
=USD 2,400
 
Net Profit=Gain from Option Exercise - Investment
=USD 5,248 - USD 2,400
=USD 2,848
 
Return on Investment=119%

Sell-to-Close Call Option

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.

Learn More About Live Cattle Futures & Options Trading

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