If you are bearish on rice, you can profit from a fall in rice price by buying (going long) rice put options.
You observed that the near-month CBOT Rough Rice futures contract is trading at the price of USD 13.71 per hundredweight. A CBOT Rice put option with the same expiration month and a nearby strike price of USD 14.00 is being priced at USD 0.9100/cwt. Since each underlying CBOT Rough Rice futures contract represents 2,000 hundredweights of rice, the premium you need to pay to own the put option is USD 1,820.
Assuming that by option expiration day, the price of the underlying rice futures has fallen by 15% and is now trading at USD 11.65 per hundredweight. At this price, your put option is now in the money.
By exercising your put option now, you get to assume a short position in the underlying rice futures at the strike price of USD 14.00. In other words, it also means that you get to sell 2,000 hundredweights of rice at USD 14.00/cwt on delivery day.
To take profit, you enter an offsetting long futures position in one contract of the underlying rice futures at the market price of USD 11.65 per hundredweight, resulting in a gain of USD 2.3500/cwt. Since each CBOT Rough Rice put option covers 2,000 hundredweights of rice, gain from the long put position is USD 4,700. Deducting the initial premium of USD 1,820 you paid to purchase the put option, your net profit from the long put strategy will come to USD 2,880.
|Long Rice Put Option Strategy|
|Gain from Option Exercise||=||(Option Strike Price - Market Price of Underlying Futures) x Contract Size|
|=||(USD 14.00/cwt - USD 11.65/cwt) x 2000 cwt|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Gain from Option Exercise - Investment|
|=||USD 4,700 - USD 1,820|
|Return on Investment||=||158%|
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 rice option sale will be equal to it's intrinsic value.
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