Buying Pork Bellies Call Options to Profit from a Rise in Pork Bellies Prices
If you are bullish on pork bellies, you can profit from a rise in pork bellies price by buying (going long) pork bellies call options.
Example: Long Pork Bellies Call Option
You observed that the near-month CME Frozen Pork Bellies futures contract is trading at the price of USD 0.8470 per pound. A CME Pork Bellies call option with the same expiration month and a nearby strike price of USD 0.8500 is being priced at USD 0.0600/lb. Since each underlying CME Frozen Pork Bellies futures contract represents 40000 pounds of pork bellies, 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 pork bellies futures has risen by 15% and is now trading at USD 0.9740 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 pork bellies futures at the strike price of USD 0.8500. This means that you get to buy the underlying pork bellies at only USD 0.8500/lb on delivery day.
To take profit, you enter an offsetting short futures position in one contract of the underlying pork bellies futures at the market price of USD 0.9741 per pound, resulting in a gain of USD 0.1240/lb. Since each CME Frozen Pork Bellies call option covers 40000 pounds of pork bellies, gain from the long call position is USD 4,960. 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 2,560.
| Long Pork Bellies Call Option Strategy | ||
| Gain from Option Exercise | = | (Market Price of Underlying Futures - Option Strike Price) x Contract Size |
| = | (USD 0.9740/lb - USD 0.8500/lb) x 40000 lb | |
| = | USD 4,960 | |
| Investment | = | Initial Premium Paid |
| = | USD 2,400 | |
| Net Profit | = | Gain from Option Exercise - Investment |
| = | USD 4,960 - USD 2,400 | |
| = | USD 2,560 | |
| Return on Investment | = | 107% |
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 pork bellies option sale will be equal to it's intrinsic value.
Related Articles
- Pork Bellies Futures Basics
- Buying Pork Bellies Futures to Profit from a Rise in Pork Bellies Prices
- Selling Pork Bellies Futures to Profit from a Fall in Pork Bellies Prices
- Pork Bellies Options Basics
- Pork Bellies Put Option Trading Basics
- Hedging Against Rising Pork Bellies Prices with Pork Bellies Futures
- Hedging Against Falling Pork Bellies Prices with Pork Bellies Futures
