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

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

Example: Long Wheat Call Option

You observed that the near-month Euronext Milling Wheat futures contract is trading at the price of EUR 146.50 per tonne. A Euronext Wheat call option with the same expiration month and a nearby strike price of EUR 150.00 is being priced at EUR 9.7700/ton. Since each underlying Euronext Milling Wheat futures contract represents 50 tonnes of wheat, the premium you need to pay to own the call option is EUR 488.50.

Assuming that by option expiration day, the price of the underlying wheat futures has risen by 15% and is now trading at EUR 168.50 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 wheat futures at the strike price of EUR 150.00. This means that you get to buy the underlying wheat at only EUR 150.00/ton on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying wheat futures at the market price of EUR 168.48 per tonne, resulting in a gain of EUR 18.50/ton. Since each Euronext Milling Wheat call option covers 50 tonnes of wheat, gain from the long call position is EUR 925.00. Deducting the initial premium of EUR 488.50 you paid to buy the call option, your net profit from the long call strategy will come to EUR 436.50.

Long Wheat Call Option Strategy
Gain from Option Exercise = (Market Price of Underlying Futures – Option Strike Price) x Contract Size
= (EUR 168.50/ton – EUR 150.00/ton) x 50 ton
= EUR 925.00
Investment = Initial Premium Paid
= EUR 488.50
Net Profit = Gain from Option Exercise – Investment
= EUR 925.00 – EUR 488.50
= EUR 436.50
Return on Investment = 89%

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

Learn More About Wheat 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 (Going Long) Wheat Futures to Profit from a Rise in Wheat Prices

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

Example: Long Wheat Futures Trade

You decide to go long one near-month CBOT Wheat Futures contract at the price of USD 5.7000 per bushel. Since each CBOT Wheat Futures contract represents 5000 bushels of wheat, the value of the futures contract is USD 28,500. However, instead of paying the full value of the contract, you will only be required to deposit an initial margin of USD 3,375 to open the long futures position.

Assuming that a week later, the price of wheat rises and correspondingly, the price of wheat futures jumps to USD 6.2700 per bushel. Each contract is now worth USD 31,350. So by selling your futures contract now, you can exit your long position in wheat futures with a profit of USD 2,850.

Long Wheat Futures Strategy: Buy LOW, Sell HIGH
BUY 5000 bushels of wheat at USD 5.7000/bu USD 28,500
SELL 5000 bushels of wheat at USD 6.2700/bu USD 31,350
Profit USD 2,850
Investment (Initial Margin) USD 3,375
Return on Investment 84.4444%

Margin Requirements & Leverage

In the examples shown above, although wheat prices have moved by only 10%, the ROI generated is 84.4444%. This leverage is made possible by the relatively low margin (approximately 11.8421%) required to control a large amount of wheat 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 Wheat 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. ]

Buying a Call Option

Dan Kenyon/Getty Images

Traders buy a call option in the commodities or futures markets if they expect the underlying futures price to move higher.

Buying a call option entitles the buyer of the option the right to purchase the underlying futures contract at the strike price any time before the contract expires. This rarely happens, and there is not much benefit to doing this, so don’t get caught up in the formal definition of buying a call option.

Most traders buy call options because they believe a commodity market is going to move higher and they want to profit from that move. You can also exit the option before it expires—during market hours, of course.

All options have a limited life. They are defined by a specific expiration date by the futures exchange where it trades. You can visit each futures exchange’s website for specific expiration dates of each commodities market.

Finding the Proper Call Options to Buy

You must first decide on your objectives and then find the best option to buy. Things to consider when buying call options include:

  • Duration of time you plan on being in the trade
  • The amount you can allocate to buying a call option
  • The length of a move you expect from the market

Most commodities and futures have a wide range of options in different expiration months and different strike prices that allow you to pick an option that meets your objectives.

Duration of Time You Plan on Being in the Call Option Trade

This will help you determine how much time you need for a call option. If you are expecting a commodity to complete its move higher within two weeks, you will want to buy a commodity with at least two weeks of time remaining on it. Typically, you don’t want to buy an option with six to nine months remaining if you only plan on being in the trade for a couple of weeks, since the options will be more expensive and you will lose some leverage.

One thing to be aware of is that the time premium of options decays more rapidly in the last 30 days.   Therefore, you could be correct in your assumptions about a trade, but the option loses too much time value and you end up with a loss. We suggest that you always buy an option with 30 more days than you expect to be in the trade.

Amount You Can Allocate to Buying a Call Option

Depending on your account size and risk tolerances, some options may be too expensive for you to buy, or they might not be the right options altogether. In the money call, options will be more expensive than out of the money options. Also, the more time remaining on the call options there is, the more they will cost.

Unlike futures contracts, there is a margin when you buy most options. You have to pay the whole option premium up front. Therefore, options in volatile markets like crude oil can cost several thousand dollars. That may not be suitable for all options traders, and you don’t want to make the mistake of buying deep out of the money options just because they are in your price range. Most deep out of the money options will expire worthlessly, and they are considered long shots.

Length of a Move You Expect From the Market

To maximize your leverage and control your risk, you should have an idea of what type of move you expect from the commodity or futures market. The more conservative approach is usually to buy in the money options.

A more aggressive approach is to buy multiple contracts of out of the money options. Your returns will increase with multiple contracts of out-of-the-money options if the market makes a large move higher. It is also riskier as you have a greater chance of losing the entire option premium if the market doesn’t move.

Call Options vs. a Futures Contract

Your losses on buying a call option are limited to the premium you paid for the option plus commissions and any fees. With a futures contract, you have virtually unlimited loss potential.

Call options also do not move as quickly as futures contracts unless they are deep in the money. This allows a commodity trader to ride out many of the ups and downs in the markets that might force a trader to close a futures contract in order to limit risk.

One of the major drawbacks to buying options is the fact that options lose time value every day. Options are a wasting asset. You not only have to be correct regarding the direction of the market but also on the timing of the move.

Break Even Point on Buying Call Options

Strike Price + Option Premium Paid

This formula is used at option expiration considering there is no time value left on the call options. You can obviously sell the options anytime before expiration and there will be time premium remaining unless the options are deep in the money or far out of the money. 

A Stop-Loss Instrument

A call option can also serve as a limited-risk stop-loss instrument for a short position. In volatile markets, it is advisable for traders and investors to use stops against risk positions. A stop is a function of risk-reward, and as the most successful market participants know, you should never risk more than you are looking to make on any investment.

The problem with stops is that sometimes the market can trade to a level that triggers a stop and then reverse. For those with short positions, a long call option serves as stop-loss protection, but it can give you more time than a stop that closes the position when it trades to the risk level. That is because if the option has time left if the market becomes volatile, the call option serves two purposes.

  1. First, the call option will act as price insurance, protecting the short position from additional losses above the strike price.
  2. Second, and perhaps more importantly, the call option allows the opportunity to stay short even if the price moves above the insured level or the strike price.

Markets often rise only to turn around and fall dramatically after the price triggers stop orders. As long as the option still has time until expiration, the call option will keep a market participant in a short position and allow them to survive a volatile period that eventually returns to a downtrend. A short position together with a long call is essentially the same as a long put position, which has limited risk.

Call options are instruments that can be employed to position directly in a market to bet that the price will appreciate or to protect an existing short position from an adverse price 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: :???: :?: :!: