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

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

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

Example: Long Rapeseed Put Option

You observed that the near-month Euronext Rapeseed futures contract is trading at the price of EUR 292.50 per tonne. A Euronext Rapeseed put option with the same expiration month and a nearby strike price of EUR 290.00 is being priced at EUR 19.50/ton. Since each underlying Euronext Rapeseed futures contract represents 50 tonnes of rapeseed, the premium you need to pay to own the put option is EUR 975.00.

Assuming that by option expiration day, the price of the underlying rapeseed futures has fallen by 15% and is now trading at EUR 248.60 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 rapeseed futures at the strike price of EUR 290.00. In other words, it also means that you get to sell 50 tonnes of rapeseed at EUR 290.00/ton on delivery day.

To take profit, you enter an offsetting long futures position in one contract of the underlying rapeseed futures at the market price of EUR 248.63 per tonne, resulting in a gain of EUR 41.40/ton. Since each Euronext Rapeseed put option covers 50 tonnes of rapeseed, gain from the long put position is EUR 2,070. Deducting the initial premium of EUR 975.00 you paid to purchase the put option, your net profit from the long put strategy will come to EUR 1,095.

Long Rapeseed Put Option Strategy
Gain from Option Exercise = (Option Strike Price – Market Price of Underlying Futures) x Contract Size
= (EUR 290.00/ton – EUR 248.60/ton) x 50 ton
= EUR 2,070
Investment = Initial Premium Paid
= EUR 975.00
Net Profit = Gain from Option Exercise – Investment
= EUR 2,070 – EUR 975.00
= EUR 1,095
Return on Investment = 112%

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

Learn More About Rapeseed Futures & Options Trading

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

Definition:
A put option is an option contract in which the holder (buyer) has the right (but not the obligation) to sell a specified quantity of a security at a specified price (strike price) within a fixed period of time (until its expiration).

For the writer (seller) of a put option, it represents an obligation to buy the underlying security at the strike price if the option is exercised. The put option writer is paid a premium for taking on the risk associated with the obligation.

For stock options, each contract covers 100 shares.

Buying Put Options

Put buying is the simplest way to trade put options. When the options trader is bearish on particular security, he can purchase put options to profit from a slide in asset price. The price of the asset must move significantly below the strike price of the put options before the option expiration date for this strategy to be profitable.

A Simplified Example

Suppose the stock of XYZ company is trading at $40. A put option contract with a strike price of $40 expiring in a month’s time is being priced at $2. You strongly believe that XYZ stock will drop sharply in the coming weeks after their earnings report. So you paid $200 to purchase a single $40 XYZ put option covering 100 shares.

Say you were spot on and the price of XYZ stock plunges to $30 after the company reported weak earnings and lowered its earnings guidance for the next quarter. With this crash in the underlying stock price, your put buying strategy will result in a profit of $800.

Let’s take a look at how we obtain this figure.

If you were to exercise your put option after earnings, you invoke your right to sell 100 shares of XYZ stock at $40 each. Although you don’t own any share of XYZ company at this time, you can easily go to the open market to buy 100 shares at only $30 a share and sell them immediately for $40 per share. This gives you a profit of $10 per share. Since each put option contract covers 100 shares, the total amount you will receive from the exercise is $1000. As you had paid $200 to purchase this put option, your net profit for the entire trade is $800.

This strategy of trading put option is known as the long put strategy. See our long put strategy article for a more detailed explanation as well as formulae for calculating maximum profit, maximum loss and breakeven points.

Protective Puts

Investors also buy put options when they wish to protect an existing long stock position. Put options employed in this manner are also known as protective puts. Entire portfolio of stocks can also be protected using index puts.

Selling Put Options

Instead of purchasing put options, one can also sell (write) them for a profit. Put option writers, also known as sellers, sell put options with the hope that they expire worthless so that they can pocket the premiums. Selling puts, or put writing, involves more risk but can be profitable if done properly.

Covered Puts

The written put option is covered if the put option writer is also short the obligated quantity of the underlying security. The covered put writing strategy is employed when the investor is bearish on the underlying.

Naked Puts

The short put is naked if the put option writer did not short the obligated quantity of the underlying security when the put option is sold. The naked put writing strategy is used when the investor is bullish on the underlying.

For the patient investor who is bullish on a particular company for the long haul, writing naked puts can also be a great strategy to acquire stocks at a discount.

Put Spreads

A put spread is an options strategy in which equal number of put option contracts are bought and sold simultaneously on the same underlying security but with different strike prices and/or expiration dates. Put spreads limit the option trader’s maximum loss at the expense of capping his potential profit at the same time.

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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

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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. ]

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