#1 A typical trade example

by admin on February 14, 2012

I guess an example will probably best illustrate how does this strategy works.

Mar Corn Futures Prices (Mar 2011 till Nov 2011)

The chart below shows a fictitious example of Mar corn futures prices from Mar 2011 till Nov 2011.

Probably you might be wondering what does the Mar futures prices mean?
It actually meant that this futures contract will expire in Mar 2012. Based on the chart above, this contract will expire in another 4 months (Dec 2011 till Mar 2012).

Corn has a planting and harvesting season therefore based on normal supply and demand, the prices for corn will be low during harvesting season (Lots of supply) and high during planting season (Low supplies).
US planting season starts from Apr and last till Jun. Harvesting starts from Oct and last till Nov.
Somehow the corn prices react to the US planting and harvesting months such as there is a tendency to hit a high price around June and low price around Nov.

Based on the chart above it can be seen that corn prices is already quite low and it should not get any lower than $6 during Nov (US harvesting season).
A put option could be sold at $5 (Corn prices) for maybe $300. That means, $300 will be received if the Mar futures corn prices never reach $5 or below in the next 4 months when the contract expire.

Put option is a contract between two parties whereby as a seller you are obligated to purchase the corn futures contract at $5 if the buyer exercise the option.

But why $5? –> Of course you can sell put option as low the there is a market for it. But do note the lower the put option prices, the lesser the amount of money you will be receiving. Based on this example, $5 has never been reached for the past 9 months and furthermore the price normally should hit a low price during Nov which is the harvesting season. Therefore $5 should be a safe margin as long as there is no drastic changes in corn production.

Mar Corn Futures Prices (Mar 2011 till Mar 2012)

The chart below shows a fictitious example of Mar corn futures prices from Mar 2011 till Mar 2012.

As can be seen from the chart above, corn prices never reach $5 and during the contract expiry month (Mar 2012) it was actually at $7.
Therefore the $300 will be kept as a profit. Not too bad for not doing much for 4 months and get to profit $300.
One thing to note is that $300 is based on one contract and if more contracts are sold, it would mean more profit.

Futures Contract, Options, Expiry? Confused?

Not too sure if you are confused by all these terms like futures contract, put options. I do have problem grasping these information initially.
I will try to explain it as simply as possible based on what I have learned the past few months in the next post. So stay tuned! 😀

In the meantime, if you do have any questions or any feedback about this strategy, please feel free to leave me a comment and I will try my best to answer.

Disclaimer: The author is not a licensed financial advisor and the information is provided for educational and information purposes only.
Trading commodity futures and options have large potential rewards but also contains a high level of risk and is not suitable for all investors.
Only risk capital should be used when trading futures or options.
None of the information provided constitutes a solicitation of or a recommendation to buy or sell any futures or options contracts.
Please seek the advice of a professional financial advisor before investing your money in any financial instrument.

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