Buying Natural Gas Put Options to Profit from a Fall in Natural Gas Prices

If you are bearish on natural gas, you can profit from a fall in natural gas price by buying (going long) natural gas put options.

Example: Long Natural Gas Put 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 put 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 10,000 mmBtus of natural gas, the premium you need to pay to own the put option is USD 3,700.

Assuming that by option expiration day, the price of the underlying natural gas futures has fallen by 15% and is now trading at USD 4.6880 per mmbtu. At this price, your put option is now in the money.

Gain from Put Option Exercise

By exercising your put option now, you get to assume a short position in the underlying natural gas futures at the strike price of USD 5.5000. In other words, it also means that you get to sell 10,000 mmbtus of natural gas at USD 5.5000/mmbtu on delivery day.

To take profit, you enter an offsetting long futures position in one contract of the underlying natural gas futures at the market price of USD 4.6878 per mmbtu, resulting in a gain of USD 0.8120/mmbtu. Since each NYMEX Natural Gas put option covers 10,000 mmBtus of natural gas, gain from the long put position is USD 8,120. Deducting the initial premium of USD 3,700 you paid to purchase the put option, your net profit from the long put strategy will come to USD 4,420.

Long Natural Gas Put Option Strategy
Gain from Option Exercise=(Option Strike Price - Market Price of Underlying Futures) x Contract Size
=(USD 5.5000/mmbtu - USD 4.6880/mmbtu) x 10000 mmbtu
=USD 8,120
 
Investment=Initial Premium Paid
=USD 3,700
 
Net Profit=Gain from Option Exercise - Investment
=USD 8,120 - USD 3,700
=USD 4,420
 
Return on Investment=119%

Sell-to-Close Put Option

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

Learn More About Natural Gas Futures & Options Trading

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