If you are bearish on tin, you can profit from a fall in tin price by buying (going long) tin put options.
You observed that the near-month LME Tin futures contract is trading at the price of USD 11,550 per tonne. A LME Tin put option with the same expiration month and a nearby strike price of USD 12,000 is being priced at USD 770.00/ton. Since each underlying LME Tin futures contract represents 5 tonnes of tin, the premium you need to pay to own the put option is USD 3,850.
Assuming that by option expiration day, the price of the underlying tin futures has fallen by 15% and is now trading at USD 9,818 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 tin futures at the strike price of USD 12,000. In other words, it also means that you get to sell 5 tonnes of tin at USD 12,000/ton on delivery day.
To take profit, you enter an offsetting long futures position in one contract of the underlying tin futures at the market price of USD 9,818 per tonne, resulting in a gain of USD 2,182/ton. Since each LME Tin put option covers 5 tonnes of tin, gain from the long put position is USD 10,910. Deducting the initial premium of USD 3,850 you paid to purchase the put option, your net profit from the long put strategy will come to USD 7,060.
|Long Tin Put Option Strategy|
|Gain from Option Exercise||=||(Option Strike Price - Market Price of Underlying Futures) x Contract Size|
|=||(USD 12,000/ton - USD 9,818/ton) x 5 ton|
|Investment||=||Initial Premium Paid|
|Net Profit||=||Gain from Option Exercise - Investment|
|=||USD 10,910 - USD 3,850|
|Return on Investment||=||183%|
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 tin option sale will be equal to it's intrinsic value.
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