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

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sign-Up Bonus Now!

  • Binomo
    Binomo

    Good Choice For Experienced Traders! 2nd place in the ranking!

Contents

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

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

Example: Long Nickel Put Option

You observed that the near-month LME Nickel futures contract is trading at the price of USD 10,100 per tonne. A LME Nickel put option with the same expiration month and a nearby strike price of USD 10,000 is being priced at USD 673.33/ton. Since each underlying LME Nickel futures contract represents 6 tonnes of nickel, the premium you need to pay to own the put option is USD 4,040.

Assuming that by option expiration day, the price of the underlying nickel futures has fallen by 15% and is now trading at USD 8,585 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 nickel futures at the strike price of USD 10,000. In other words, it also means that you get to sell 6 tonnes of nickel at USD 10,000/ton on delivery day.

To take profit, you enter an offsetting long futures position in one contract of the underlying nickel futures at the market price of USD 8,585 per tonne, resulting in a gain of USD 1,415/ton. Since each LME Nickel put option covers 6 tonnes of nickel, gain from the long put position is USD 8,490. Deducting the initial premium of USD 4,040 you paid to purchase the put option, your net profit from the long put strategy will come to USD 4,450.

Long Nickel Put Option Strategy
Gain from Option Exercise = (Option Strike Price – Market Price of Underlying Futures) x Contract Size
= (USD 10,000/ton – USD 8,585/ton) x 6 ton
= USD 8,490
Investment = Initial Premium Paid
= USD 4,040
Net Profit = Gain from Option Exercise – Investment
= USD 8,490 – USD 4,040
= USD 4,450
Return on Investment = 110%

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

Learn More About Nickel Futures & Options Trading

You May Also Like

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. ]

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sign-Up Bonus Now!

  • Binomo
    Binomo

    Good Choice For Experienced Traders! 2nd place in the ranking!

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 Nickel Call Options to Profit from a Rise in Nickel Prices

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

Example: Long Nickel Call Option

You observed that the near-month LME Nickel futures contract is trading at the price of USD 10,100 per tonne. A LME Nickel call option with the same expiration month and a nearby strike price of USD 10,000 is being priced at USD 673.33/ton. Since each underlying LME Nickel futures contract represents 6 tonnes of nickel, the premium you need to pay to own the call option is USD 4,040.

Assuming that by option expiration day, the price of the underlying nickel futures has risen by 15% and is now trading at USD 11,620 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 nickel futures at the strike price of USD 10,000. This means that you get to buy the underlying nickel at only USD 10,000/ton on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying nickel futures at the market price of USD 11,615 per tonne, resulting in a gain of USD 1,620/ton. Since each LME Nickel call option covers 6 tonnes of nickel, gain from the long call position is USD 9,720. Deducting the initial premium of USD 4,040 you paid to buy the call option, your net profit from the long call strategy will come to USD 5,680.

Long Nickel Call Option Strategy
Gain from Option Exercise = (Market Price of Underlying Futures – Option Strike Price) x Contract Size
= (USD 11,620/ton – USD 10,000/ton) x 6 ton
= USD 9,720
Investment = Initial Premium Paid
= USD 4,040
Net Profit = Gain from Option Exercise – Investment
= USD 9,720 – USD 4,040
= USD 5,680
Return on Investment = 141%

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

Learn More About Nickel Futures & Options Trading

You May Also Like

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. ]

Put Options Under The Spotlight: When They’re A Safe Bet [And The Dangers Of Expiring Worthless]

Sharing is caring!

Last Updated on May 18, 2020

Buying put options is a bearish strategy using leverage and is a risk-defined alternative to shorting stock. An illustration of the thought process of buying a put is given next:

  1. A trader is very bearish on a particular stock trading at $50.
  2. The trader is either risk-averse, wanting to know before hand their maximum loss or wants greater leverage than simply shorting stock.
  3. The trader expects the stock to move below $47.06 in the next 30 days.

Given those expectations, the trader selects the $47.50 put option strike price which is trading for $0.44. For this example, the trader will buy only 1 put option contract (Note: 1 contract is for 100 shares) so the total cost will be $44 ($0.44 x 100 shares/contract). The graph below of this hypothetical situation is given below:

There are numerous reasons, both technical and fundamental, why a trader could feel bearish.

Options Offer Defined Risk

When a put option is purchased, the trader instantly knows the maximum amount of money they can possibly lose. The max loss is always the premium paid to own the option contract; in this example, $44. Whether the stock rises to $55 or $100 a share, the put option holder will only lose the amount they paid for the option. This is the risk-defined benefit often discussed about as a reason to trade options.

Options offer Leverage

The other benefit is leverage. When a stock price is below its breakeven point (in this example, $47.06) the option contract at expiration acts exactly like being short stock. To illustrate, if a 100 shares of stock moves down $1, then the trader would profit $100 ($1 x $100). Likewise, below $47.06, the options breakeven point, if the stock moved down $1, then the option contract would increase by $1, thus making $100 ($1 x $100) as well.

Remember, to short the stock, the trader would have had to put up margin requirements, sometimes 150% of the present stock value ($7,500). However, the trader in this example, only paid $60 for the put option and does not need to worry about margin calls or the unlimited risk to the upside.

Options require Timing

The important part about selecting an option and option strike price, is the trader’s exact expectations for the future. If the trader expects the stock to move lower, but only $1 lower, then buying the $47.50 strike price would be foolish. This is because at expiration, if the stock price is anywhere above $47.50, whether it be $75 or $47.51, the put option will expire worthless. If a trader was correct on their prediction that the stock would move lower by $1, they would still have lost.

Similarly, if the stock moved down to $46 the day after the put option expired, the trader still would have lost all their premium paid for the option. Simply stated, when buying options, you need to predict the correct direction of stock movement, the size of the stock movement, and the time period the stock movement will occur–more complicated then shorting stock, when all a person is doing is predicting that the stock will move in their predicted direction downward.

Put Options Profit, Loss, Breakeven

The following is the profit/loss graph at expiration for the put option in the example given on the previous page.

Break-even

The breakeven point is quite easy to calculate for a put option:

  • Breakeven Stock Price = Put Option Strike Price – Premium Paid

To illustrate, the trader purchased the $47.50 strike price put option for $0.44. Therefore, $47.50 – $0.44 = $47.06. The trader will breakeven, excluding commissions/slippage, if the stock falls to $47.06 by expiration.

Profit

To calculate profits or losses on a put option use the following simple formula:

  • Put Option Profit/Loss = Breakeven Point – Stock Price at Expiration

For every dollar the stock price falls once the $47.06 breakeven barrier has been surpassed, there is a dollar for dollar profit for the options contract. So if the stock falls $5.00 to $45.00 by expiration, the owner of the the put option would make $2.06 per share ($47.06 breakeven stock price – $45.00 stock price at expiration). So total, the trader would have made $206 ($2.06 x 100 shares/contract).

Partial Loss

If the stock price decreased by $2.75 to close at $47.25 by expiration, the option trader would lose money. For this example, the trader would have lost $0.19 per contract ($47.06 breakeven stock price – $47.25 stock price). Therefore, the hypothetical trader would have lost $19 (-$0.19 x 100 shares/contract).

To summarize, in this partial loss example, the option trader bought a put option because they thought that the stock was going to fall. By all accounts, the trader was right, the stock did fall by $2.75, however, the trader was not right enough. The stock needed to move lower by at least $2.94 to $47.06 to breakeven.

Complete Loss

If the stock did not move lower than the strike price of the put option contract by expiration, the option trader would lose their entire premium paid $0.44. Likewise, if the stock moved up, irrelavent by how much it moved upward, then the option trader would still lose the $0.44 paid for the option. In either of those two circumstances, the trader would have lost $44 (-$0.44 x 100 shares/contract).

Again, this is where the limited risk part of option buying comes in: the stock could have risen 20 points, potentially blowing out a trader shorting the stock, but the option contract owner would still only lose their premium paid, in this case $0.44.

Buying put options has many positive benefits like defined-risk and leverage, but like everything else, it has its downside, which is explored on the next page.

Downside of Buying Put Options

Take another look at the put option profit/loss graph. This time, think about how far away from the current stock price of $50, the breakeven price of $47.06 is.

Put Options need Big Moves to be Profitable

Putting percentages to the breakeven number, breakeven is a 5.9% move downward in only 30 days. That sized movement is realistically possible, but highly unlikely in only 30 days. Plus, the stock has to move down more than the 5.9% to even start to make a cent of profit, profit being the whole purpose of entering into a trade. To begin with, a comparison of shorting 100 shares and buying 1 put option contract ($47.50 strike price) will be given:

  • 100 shares: $50 x 100 shares = $7,500 margin deposit ($5,000 received for sold shares + 50% of the $5,000 as additional margin)
  • 1 call option: $0.44 x 100 shares/contract = $44; keeps the rest ($7,456) in savings.

If the stock moves down 2% in the next 30 days, the shortseller makes $100; the call option holder loses $44:

  • Shortseller: Gains $100 or 1.3%
  • Option Holder: Loses $44 or 0.6% of total capital

If the stock moves down 5% in the following 30 days:

  • Shortseller: Gains $250 or 3.3%
  • Option Holder: Loses $44 or 0.6%

If the stock moves down 8% over the next 30 days, the option holder finally begins to make money:

  • Shortseller: Gains $400 or 5.3%
  • Option Holder: Gains $106 or 1.4%

It’s fair to say, that buying these out-of-the money (OTM) put options and hoping for a larger than 5.9% move lower in the stock is going to result in numerous times when the trader’s call options will expire worthless. However, the benefit of buying put options to preserve capital does have merit.

Capital Preservation

Substantial losses can be incredibly devastating. For an extreme example, a 50% loss means a trader has to make 100% profit on their next trade in order to breakeven. Also, it is important to emphasize that shorting stock is very risky, since, theoretically, stocks can increase to infinity. This means shorting stock has unlimited risk to the upside.

Buying put options and continuing the prior examples, a trader is only risking a small 0.6% of capital for each trade. This prevents the trader from incurring a single substantial loss, which is a real reality when stock trading. For example, a simple small loss from a 5% move higher is easier to take for an option put holder than a shortseller:

  • Shortseller: Loses $250 or 3.3%
  • Option Holder: Loses $44 or 0.6%

For a catastrophic 20% move higher in the stock, things get much worse for the shortseller:

  • Shortseller: Loses $1,000 or 13.3%
  • Option Holder: Loses $44 or 0.6%

In the case of the 20% stock move higher, the option holder can strike out for over 22 months and still not lose as much as the shortseller.

Moral of the story

Options are tools offering the benefits of leverage and defined risk. But like all tools, they are best used in specialized circumstances. Options require a trader to take into consideration:

  1. The direction the stock will move.
  2. How much the stock will move
  3. The time frame the stock will make its move
Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Perfect For Beginners!
    Free Demo Account!
    Free Trading Education!
    Get Your Sign-Up Bonus Now!

  • Binomo
    Binomo

    Good Choice For Experienced Traders! 2nd place in the ranking!

Like this post? Please share to your friends:
Guide How To Become Binary Options Trader
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: