Buying Zinc Call Options to Profit from a Rise in Zinc Prices
If you are bullish on zinc, you can profit from a rise in zinc price by buying (going long) zinc call options.
Example: Long Zinc Call Option
You observed that the near-month LME Zinc futures contract is trading at the price of USD 1,212 per tonne. A LME Zinc call option with the same expiration month and a nearby strike price of USD 1,200 is being priced at USD 80.80/ton. Since each underlying LME Zinc futures contract represents 25 tonnes of zinc, the premium you need to pay to own the call option is USD 2,020.
Assuming that by option expiration day, the price of the underlying zinc futures has risen by 15% and is now trading at USD 1,394 per tonne. At this price, your call option is now in the money.
Gain from Call Option Exercise
By exercising your call option now, you get to assume a long position in the underlying zinc futures at the strike price of USD 1,200. This means that you get to buy the underlying zinc at only USD 1,200/ton on delivery day.
To take profit, you enter an offsetting short futures position in one contract of the underlying zinc futures at the market price of USD 1,394 per tonne, resulting in a gain of USD 194.00/ton. Since each LME Zinc call option covers 25 tonnes of zinc, gain from the long call position is USD 4,850. Deducting the initial premium of USD 2,020 you paid to buy the call option, your net profit from the long call strategy will come to USD 2,830.
| Long Zinc Call Option Strategy | ||
| Gain from Option Exercise | = | (Market Price of Underlying Futures - Option Strike Price) x Contract Size |
| = | (USD 1,394/ton - USD 1,200/ton) x 25 ton | |
| = | USD 4,850 | |
| Investment | = | Initial Premium Paid |
| = | USD 2,020 | |
| Net Profit | = | Gain from Option Exercise - Investment |
| = | USD 4,850 - USD 2,020 | |
| = | USD 2,830 | |
| Return on Investment | = | 140% |
Sell-to-Close Call Option
In practice, there is often no need to exercise the call option to realise the profit. You can close out the position by selling the call 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 zinc option sale will be equal to it's intrinsic value.
Related Articles
- Zinc Futures Basics
- Buying Zinc Futures to Profit from a Rise in Zinc Prices
- Selling Zinc Futures to Profit from a Fall in Zinc Prices
- Zinc Options Basics
- Zinc Put Option Trading Basics
- Hedging Against Rising Zinc Prices with Zinc Futures
- Hedging Against Falling Zinc Prices with Zinc Futures
