This historical lesson covers the discontinued CME pork-bellies contract. Pork Bellies put options give a buyer exposure to falling futures prices. Follow one contract from premium paid to its result at expiration.
How pork bellies options work
The examples use options on frozen pork bellies (discontinued) futures. A call gives the right to enter a long futures position at the strike price. A put gives the right to enter a short futures position at that price.
The historical examples explain option arithmetic. They do not describe a currently listed CME pork-bellies option.
The cost of one option
One CME contract represented 40,000 pounds. The exchange quotes this product in cents per pound; the examples convert those quotes into dollars. A premium of 5 cents equals $0.05 per pound. At a premium of $0.05 per pound, one option costs $2,000 ($0.05 × 40,000).
Assume the futures price and strike are both $1 per pound. The call and put premiums are each $0.05 for comparison, not current quotes. Results below are at expiration, before fees, with any futures position from exercise immediately closed at the stated price.
Buying pork bellies puts
If you expect prices to fall instead, buying one $1 put costs $2,000 in this example.
At a futures price of $0.85 per pound, selling at the strike gives an advantage of $0.15 per pound. The option is worth $6,000 at expiration, leaving a $4,000 net profit after the premium.
At $1 or above, the put expires worthless. Breakeven is $0.95 per pound. At $0.975, the price has fallen, but the put still loses $1,000: the move has not covered its premium.
Before expiration
An option can be sold to close before expiration when a market is available. Its price then includes the effect of remaining time and implied volatility, so an earlier trade need not break even at the expiration price calculated above.
The purchased option can lose its whole premium. Exercise can create a futures position requiring margin and exposing you to further gains or losses. An uncovered seller can lose more than the premium received.
Price chart and contract status
The former CME frozen pork-bellies futures and options were delisted in 2011. There is no current chart for that discontinued contract. Lean Hog Options has a chart for a different, currently traded benchmark; it is not a pork-belly price.
