Buying Natural Gas Call Options to Profit from a Rise in Natural Gas Prices

If you are bullish on natural gas, you can profit from a rise in natural gas price by buying (going long) natural gas call options.

Example: Long Natural Gas Call Option

You observed that the near-month NYMEX Natural Gas futures contract is trading at the price of USD 5.5150 per mmbtu. A NYMEX Natural Gas call option with the same expiration month and a nearby strike price of USD 5.5000 is being priced at USD 0.3700/mmbtu. Since each underlying NYMEX Natural Gas futures contract represents 10000 mmBtus of natural gas, the premium you need to pay to own the call option is USD 3,700.

Assuming that by option expiration day, the price of the underlying natural gas futures has risen by 15% and is now trading at USD 6.3420 per mmbtu. 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 natural gas futures at the strike price of USD 5.5000. This means that you get to buy the underlying natural gas at only USD 5.5000/mmbtu on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying natural gas futures at the market price of USD 6.3423 per mmbtu, resulting in a gain of USD 0.8420/mmbtu. Since each NYMEX Natural Gas call option covers 10000 mmBtus of natural gas, gain from the long call position is USD 8,420. Deducting the initial premium of USD 3,700 you paid to buy the call option, your net profit from the long call strategy will come to USD 4,720.

Long Natural Gas Call Option Strategy
Gain from Option Exercise=(Market Price of Underlying Futures - Option Strike Price) x Contract Size
=(USD 6.3420/mmbtu - USD 5.5000/mmbtu) x 10000 mmbtu
=USD 8,420
 
Investment=Initial Premium Paid
=USD 3,700
 
Net Profit=Gain from Option Exercise - Investment
=USD 8,420 - USD 3,700
=USD 4,720
 
Return on Investment=128%

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 natural gas option sale will be equal to it's intrinsic value.

Learn More About Natural Gas Futures & Options Trading

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