Buying (Going Long) Ethanol Futures to Profit from a Rise in Ethanol Prices

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Contents

Buying (Going Long) Ethanol Futures to Profit from a Rise in Ethanol Prices

If you are bullish on ethanol, you can profit from a rise in ethanol price by taking up a long position in the ethanol futures market. You can do so by buying (going long) one or more ethanol futures contracts at a futures exchange.

Example: Long Ethanol Futures Trade

You decide to go long one near-month CBOT Ethanol Futures contract at the price of USD 1.5800 per gallon. Since each CBOT Ethanol Futures contract represents 29000 gallons of ethanol, the value of the futures contract is USD 45,820. However, instead of paying the full value of the contract, you will only be required to deposit an initial margin of USD 6,480 to open the long futures position.

Assuming that a week later, the price of ethanol rises and correspondingly, the price of ethanol futures jumps to USD 1.7380 per gallon. Each contract is now worth USD 50,402. So by selling your futures contract now, you can exit your long position in ethanol futures with a profit of USD 4,582.

Long Ethanol Futures Strategy: Buy LOW, Sell HIGH
BUY 29000 gallons of ethanol at USD 1.5800/gal USD 45,820
SELL 29000 gallons of ethanol at USD 1.7380/gal USD 50,402
Profit USD 4,582
Investment (Initial Margin) USD 6,480
Return on Investment 70.7099%

Margin Requirements & Leverage

In the examples shown above, although ethanol prices have moved by only 10%, the ROI generated is 70.7099%. This leverage is made possible by the relatively low margin (approximately 14.1423%) required to control a large amount of ethanol represented by each contract.

Leverage is a double edged weapon. The above examples only depict positive scenarios whereby the market is favorable towards you. If the market turn against you, you will be required to top up your account to meet the margin requirements in order for your futures position to remain open.

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Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Buying (Going Long) Ethanol Futures to Profit from a Rise in Ethanol Prices

Bearish strategies in options trading are employed when the options trader expects the underlying stock price to move downwards. It is necessary to assess how low the stock price can go and the timeframe in which the decline will happen in order to select the optimum trading strategy.

Very Bearish

The most bearish of options trading strategies is the simple put buying strategy utilized by most novice options traders.


Moderately Bearish

In most cases, stock price seldom make steep downward moves. Moderately bearish options traders usually set a target price for the expected decline and utilise bear spreads to reduce risk. While maximum profit is capped for these strategies, they usually cost less to employ.

Mildly Bearish

Mildly bearish trading strategies are options strategies that make money as long as the underlying stock price do not go up on options expiration date. These strategies usually provide a small upside protection as well. A good example of such a strategy is to write of out-of-the-money naked calls.

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Buying Straddles into Earnings

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Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Buying Ethanol Call Options to Profit from a Rise in Ethanol Prices

If you are bullish on ethanol, you can profit from a rise in ethanol price by buying (going long) ethanol call options.

Example: Long Ethanol Call Option

You observed that the near-month CME Ethanol futures contract is trading at the price of USD 1.5800 per gallon. A CME Ethanol call option with the same expiration month and a nearby strike price of USD 1.6000 is being priced at USD 0.1100/gal. Since each underlying CME Ethanol futures contract represents 29000 gallons of ethanol, the premium you need to pay to own the call option is USD 3,190.

Assuming that by option expiration day, the price of the underlying ethanol futures has risen by 15% and is now trading at USD 1.8170 per gallon. 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 ethanol futures at the strike price of USD 1.6000. This means that you get to buy the underlying ethanol at only USD 1.6000/gal on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying ethanol futures at the market price of USD 1.8170 per gallon, resulting in a gain of USD 0.2170/gal. Since each CME Ethanol call option covers 29000 gallons of ethanol, gain from the long call position is USD 6,293. Deducting the initial premium of USD 3,190 you paid to buy the call option, your net profit from the long call strategy will come to USD 3,103.

Long Ethanol Call Option Strategy
Gain from Option Exercise = (Market Price of Underlying Futures – Option Strike Price) x Contract Size
= (USD 1.8170/gal – USD 1.6000/gal) x 29000 gal
= USD 6,293
Investment = Initial Premium Paid
= USD 3,190
Net Profit = Gain from Option Exercise – Investment
= USD 6,293 – USD 3,190
= USD 3,103
Return on Investment = 97%

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 ethanol option sale will be equal to it’s intrinsic value.

Learn More About Ethanol Futures & Options Trading

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Continue Reading.

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Best Binary Options Brokers 2020:
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    Binarium

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    Perfect Choice For Beginners and Middle-Level Traders!
    Free Demo Account! Free Education!

  • Binomo
    Binomo

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