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7. Long Put
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Scenario:
Pork Bellies have been trading at contract highs of between 75 and 85 cents per pound. The trader feels that a major decline is very likely. However, the trader is not sure when it will come. He decides to buy a long-term put option. By doing this he initially has very little time decay. He can ride out a temporary upward move and still be in for the big break.
Specifics:
| Underlying Futures Contract: | February Pork Bellies | |
| Futures Price Level: | 80.15 | |
| Days to Futures Expiration: | 210 | |
| Days to Options Expiration: | 180 | |
| Option Implied Volatility: | 33.2% | |
| Option Position: | Long 1 Feb 76 Put | - 5.10 ($2040) |
At Expiration:
| Breakeven: | 70.90 (76.00 strike - 5.10 premium) | |
| Loss Risk: | Limited to the premium paid. Loss above 70.90 with maximum loss of 5.10 above 76.00. | |
| Potential Gain: | Unlimited, with profits increasing as the futures fall further and further past 70.90 breakeven. | |
Things to Watch:
This trader must be very bearish, with volatility increasing, to make this trade profitable. If held to expiration, the futures would have to fall more than 10% by expiration just to break even. Check the follow-up strategies if the futures fall or volatility rises to the levels expected before expiration.
Follow-up Trading Strategies
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