Buying Silver Put Options to Profit from a Fall in Silver Prices

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

Example: Long Silver Put Option

You observed that the near-month NYMEX Silver futures contract is trading at the price of USD 11.30 per troy ounce. A NYMEX Silver put option with the same expiration month and a nearby strike price of USD 11.00 is being priced at USD 0.7500/oz. Since each underlying NYMEX Silver futures contract represents 5,000 troy ounces of silver, the premium you need to pay to own the put option is USD 3,750.

Assuming that by option expiration day, the price of the underlying silver futures has fallen by 15% and is now trading at USD 9.6010 per troy ounce. 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 silver futures at the strike price of USD 11.00. In other words, it also means that you get to sell 5,000 troy ounces of silver at USD 11.00/oz on delivery day.

To take profit, you enter an offsetting long futures position in one contract of the underlying silver futures at the market price of USD 9.6008 per troy ounce, resulting in a gain of USD 1.3990/oz. Since each NYMEX Silver put option covers 5,000 troy ounces of silver, gain from the long put position is USD 6,995. Deducting the initial premium of USD 3,750 you paid to purchase the put option, your net profit from the long put strategy will come to USD 3,245.

Long Silver Put Option Strategy
Gain from Option Exercise=(Option Strike Price - Market Price of Underlying Futures) x Contract Size
=(USD 11.00/oz - USD 9.6010/oz) x 5000 oz
=USD 6,995
Investment=Initial Premium Paid
=USD 3,750
Net Profit=Gain from Option Exercise - Investment
=USD 6,995 - USD 3,750
=USD 3,245
Return on Investment=87%

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

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