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

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Contents

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

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

Example: Long Sugar Call Option

You observed that the near-month Euronext White Sugar (No. 407) futures contract is trading at the price of USD 324.60 per tonne. A Euronext Sugar call option with the same expiration month and a nearby strike price of USD 320.00 is being priced at USD 21.64/ton. Since each underlying Euronext White Sugar (No. 407) futures contract represents 50 tonnes of sugar, the premium you need to pay to own the call option is USD 1,082.

Assuming that by option expiration day, the price of the underlying sugar futures has risen by 15% and is now trading at USD 373.30 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 sugar futures at the strike price of USD 320.00. This means that you get to buy the underlying sugar at only USD 320.00/ton on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying sugar futures at the market price of USD 373.29 per tonne, resulting in a gain of USD 53.30/ton. Since each Euronext White Sugar (No. 407) call option covers 50 tonnes of sugar, gain from the long call position is USD 2,665. Deducting the initial premium of USD 1,082 you paid to buy the call option, your net profit from the long call strategy will come to USD 1,583.

Long Sugar Call Option Strategy
Gain from Option Exercise = (Market Price of Underlying Futures – Option Strike Price) x Contract Size
= (USD 373.30/ton – USD 320.00/ton) x 50 ton
= USD 2,665
Investment = Initial Premium Paid
= USD 1,082
Net Profit = Gain from Option Exercise – Investment
= USD 2,665 – USD 1,082
= USD 1,583
Return on Investment = 146%

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

Learn More About Sugar Futures & Options Trading

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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. ]

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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. ]

Selling (Going Short) Sugar Futures to Profit from a Fall in Sugar Prices

If you are bearish on sugar, you can profit from a fall in sugar price by taking up a short position in the sugar futures market. You can do so by selling (shorting) one or more sugar futures contracts at a futures exchange.

Example: Short Sugar Futures Trade

You decide to go short one near-month Euronext Raw Sugar (No. 408) Futures contract at the price of USD 0.1111/lb. Since each Raw Sugar (No. 408) futures contract represents 112000 pounds of sugar, the value of the contract is USD 12,443. To enter the short futures position, you have to put up an initial margin of USD 1,456.

A week later, the price of sugar falls and correspondingly, the price of Euronext Raw Sugar (No. 408) futures drops to USD 0.1000 per pound. Each contract is now worth only USD 11,199. So by closing out your futures position now, you can exit your short position in Raw Sugar (No. 408) Futures with a profit of USD 1,244.

Short Sugar Futures Strategy: Sell HIGH, Buy LOW
SELL 112000 pounds of sugar at USD 0.1111/lb USD 12,443
BUY 112000 pounds of sugar at USD 0.1000/lb USD 11,199
Profit USD 1,244
Investment (Initial Margin) USD 1,456
Return on Investment 85.4615%

Margin Requirements & Leverage

In the examples shown above, although sugar prices have moved by only 10%, the ROI generated is 0.0000%. This leverage is made possible by the relatively low margin (approximately 11.7012%) required to control a large amount of sugar 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.

Learn More About Sugar 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. ]

Options Trading Strategies: A Guide for Beginners

Options are conditional derivative contracts that allow buyers of the contracts (option holders) to buy or sell a security at a chosen price. Option buyers are charged an amount called a “premium” by the sellers for such a right. Should market prices be unfavorable for option holders, they will let the option expire worthless, thus ensuring the losses are not higher than the premium. In contrast, option sellers (option writers) assume greater risk than the option buyers, which is why they demand this premium.

Options are divided into “call” and “put” options. With a call option, the buyer of the contract purchases the right to buy the underlying asset in the future at a predetermined price, called exercise price or strike price. With a put option, the buyer acquires the right to sell the underlying asset in the future at the predetermined price.

Why Trade Options Rather Than a Direct Asset?

There are some advantages to trading options. The Chicago Board of Options Exchange (CBOE) is the largest such exchange in the world, offering options on a wide variety of single stocks, ETFs and indexes. Traders can construct option strategies ranging from buying or selling a single option to very complex ones that involve multiple simultaneous option positions.

The following are basic option strategies for beginners.

Buying Calls (Long Call)

This is the preferred strategy for traders who:

  • Are “bullish” or confident on a particular stock, ETF or index and want to limit risk
  • Want to utilize leverage to take advantage of rising prices

Options are leveraged instruments, i.e., they allow traders to amplify the benefit by risking smaller amounts than would otherwise be required if trading the underlying asset itself. A standard option contract on a stock controls 100 shares of the underlying security.

Suppose a trader wants to invest $5,000 in Apple (AAPL), trading around $165 per share. With this amount, he or she can purchase 30 shares for $4,950. Suppose then that the price of the stock increases by 10% to $181.50 over the next month. Ignoring any brokerage, commission or transaction fees, the trader’s portfolio will rise to $5,445, leaving the trader with a net dollar return of $495, or 10% on the capital invested.

Now, let’s say a call option on the stock with a strike price of $165 that expires about a month from now costs $5.50 per share or $550 per contract. Given the trader’s available investment budget, he or she can buy nine options for a cost of $4,950. Because the option contract controls 100 shares, the trader is effectively making a deal on 900 shares. If the stock price increases 10% to $181.50 at expiration, the option will expire in the money and be worth $16.50 per share ($181.50-$165 strike), or $14,850 on 900 shares. That’s a net dollar return of $9,990, or 200% on the capital invested, a much larger return compared to trading the underlying asset directly. (For related reading, see “Should an Investor Hold or Exercise an Option?”)

Risk/Reward: The trader’s potential loss from a long call is limited to the premium paid. Potential profit is unlimited, as the option payoff will increase along with the underlying asset price until expiration, and there is theoretically no limit to how high it can go.

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

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