Question

Assume you are a corn farmer who anticipates harvesting and selling about 100,000 bushels or Corn in the autumn. Assume you think that prices are currently high, $2.40 per bushel, and you want to hedge yourself. Discuss two possible hedging strategies :(1) based on futures / forwards, and(2) based on options. Assume that the relevant positions have contract prices or exercise prices of $2.50 per bushel. The price of the option is $ 0.12(12 cents) per bushel. Indicate how your “real position, derivative position, and overall outcome” depends on the final corn price and on the hedging strategy. In each case, you might indicate the outcomes if corn next Autumn turns out to be $2.00 or $2.50 or $3.00 per bushel. You should give part of the numerical answer in “per bushel” terms, AND some of the$$answer based on100,000 bushels

Answer 1

BASED ON FUTURES/FORWARD:

FORWARD CONTRACT:

Amount to be received per bushel=$2.50

Total amount to be received=100000*$2.50=$250,000

This amount is constant irrespective of next Autumn price ($2.00, $2.50 or $3.00)

FUTURE CONTRACT:

Contract Price =$2.50

Total amount to be received=100000*$2.50=$250,000

This amount is constant irrespective of next Autumn price ($2.00, $2.50 or $3.00)

(2) OPTION CONTRACT

Selling at exercise Price=$2.50

S= Price at expiration

Payoff from Option =Max.((2.50-S),0)

Price of Option =$0.12

Net Profit From Option = Max.((2.50-S),0)-$0.12

If S=$2.00

Net Profit per bushel=(2.50-2.00)-$0.12=$0.38

Total Profit =100000*$0.38=$38,000

Amount to be received from Spot =100000*$2.00=$200000

Total amount will be received=200000+38000=$238,000

If S=$2.50

Net Profit per bushel=0-$0.12=-$0.12

Total Profit =100000*(-0.12)=-$12,000

Amount to be received from Spot =100000*$2.50=$250000

Total amount will be received=250000-12000=$238,000

If S=$3.00

Net Profit per bushel=0-$0.12=-$0.12

Total Profit =100000*(-0.12)=-$12,000

Amount to be received from Spot =100000*$3.00=$300000

Total amount will be received=300000-12000=$288,000