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

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

Example: Long Wheat Put Option

You observed that the near-month Euronext Milling Wheat futures contract is trading at the price of EUR 146.50 per tonne. A Euronext Wheat put option with the same expiration month and a nearby strike price of EUR 150.00 is being priced at EUR 9.7700/ton. Since each underlying Euronext Milling Wheat futures contract represents 50 tonnes of wheat, the premium you need to pay to own the put option is EUR 488.50.

Assuming that by option expiration day, the price of the underlying wheat futures has fallen by 15% and is now trading at EUR 124.50 per tonne. 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 wheat futures at the strike price of EUR 150.00. In other words, it also means that you get to sell 50 tonnes of wheat at EUR 150.00/ton on delivery day.

To take profit, you enter an offsetting long futures position in one contract of the underlying wheat futures at the market price of EUR 124.53 per tonne, resulting in a gain of EUR 25.50/ton. Since each Euronext Milling Wheat put option covers 50 tonnes of wheat, gain from the long put position is EUR 1,275. Deducting the initial premium of EUR 488.50 you paid to purchase the put option, your net profit from the long put strategy will come to EUR 786.50.

Long Wheat Put Option Strategy
Gain from Option Exercise=(Option Strike Price - Market Price of Underlying Futures) x Contract Size
=(EUR 150.00/ton - EUR 124.50/ton) x 50 ton
=EUR 1,275
 
Investment=Initial Premium Paid
=EUR 488.50
 
Net Profit=Gain from Option Exercise - Investment
=EUR 1,275 - EUR 488.50
=EUR 786.50
 
Return on Investment=161%

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

Learn More About Wheat Futures & Options Trading

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