If you are bearish on sugar, you can profit from a fall in sugar price by buying (going long) sugar put options.
You observed that the near-month Euronext White Sugar (No. 407) futures contract is trading at the price of USD 324.60 per tonne. A Euronext Sugar put option with the same expiration month and a nearby strike price of USD 320.00 is being priced at USD 21.64/ton. Since each underlying Euronext White Sugar (No. 407) futures contract represents 50 tonnes of sugar, the premium you need to pay to own the put option is USD 1,082.
Assuming that by option expiration day, the price of the underlying sugar futures has fallen by 15% and is now trading at USD 275.90 per tonne. 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 sugar futures at the strike price of USD 320.00. In other words, it also means that you get to sell 50 tonnes of sugar at USD 320.00/ton on delivery day.
To take profit, you enter an offsetting long futures position in one contract of the underlying sugar futures at the market price of USD 275.91 per tonne, resulting in a gain of USD 44.10/ton. Since each Euronext White Sugar (No. 407) put option covers 50 tonnes of sugar, gain from the long put position is USD 2,205. Deducting the initial premium of USD 1,082 you paid to purchase the put option, your net profit from the long put strategy will come to USD 1,123.
|Long Sugar Put Option Strategy|
|Gain from Option Exercise||=||(Option Strike Price - Market Price of Underlying Futures) x Contract Size|
|=||(USD 320.00/ton - USD 275.90/ton) x 50 ton|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Gain from Option Exercise - Investment|
|=||USD 2,205 - USD 1,082|
|Return on Investment||=||104%|
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 sugar option sale will be equal to it's intrinsic value.
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