Question

Six months from now, Farmer Don will harvest 10,000 bushels of corn. In doing so, he incurs costs of $32,000. The current spot price of corn is $3.50 per bushel, and the effective six-month interest rate is 5 percent. Don has decided to hedge with a collar by purchasing $3.30-strike puts and selling $3.70-strike calls on 10,000 bushels of corn. The puts have a premium of $0.16 per bushel, while the calls have a premium of $0.31 per bushel. What total profit would Don earn if the market price of corn at harvest time is $2.90, $3.30, $3.70, and $4.10, respectively?

Answer 1

	Cost of purchasing put(Long)	$0.16
	Amount received for call(Short)	$0.31
	Net Amount received per bushel	$0.15	(0.31-0.16)
	Six months effective interest rate=5%=	0.05
	Future Value of $0.15 after 6 months	$0.1575	(0.15*(1+0.05)
	Future Value of total net premium received	$1,575	(10000*0.16)
	Cost of harvesting 10000 bushel after 6 months	$32,000
	P	A	B	C=A+B	D=C*10000	E	F	G=P*10000	H=D+E+F+G
	Market Price at harvest time	Payoff per bushel for long put (strike$3.30)	Payoff per bushel for Short call (Strike $3.70)	Net Payoff per Bushel after six months	Net Pay off for 10000 bushel	Value of net premium received	Total Cost of haevesting	Amount received for selling corn	Total Profit Earned
	$2.90	$0.40	$0	$0.40	$4,000.00	$1,575	($32,000)	$29,000	$2,575.00
	$3.30	$0	$0	$0.00	$0.00	$1,575	($32,000)	$33,000	$2,575.00
	$3.70	$0	$0	$0.00	$0.00	$1,575	($32,000)	$37,000	$6,575.00
	$4.10	$0	($0.40)	($0.40)	($4,000.00)	$1,575	($32,000)	$41,000	$6,575.00
	Market Price at harvest time	Total Profit
	$2.90	$2,575.00
	$3.30	$2,575.00
	$3.70	$6,575.00
	$4.10	$6,575.00