Question

In: Finance

Suppose that you know today that you will be selling 15,000 bushels of corn a few...

Suppose that you know today that you will be selling 15,000 bushels of corn a few months from now. Additionally, you know that given the current cash price of $2.35/bu., you have the potential to profit. However, you are concerned that the price may move against you. You purchase a $2.50/bu. put option for $0.20/bu. and expect the basis to be $0.05 under. When you are ready to sell the corn, the cash and futures prices have decreased to $2.15/bu. and $2.20/bu., respectively. Assuming zero time value and that the broker charges a commission of $50 per option traded, answer the questions below

  1. Compute the gain/loss per bu. you have earned on options in terms of the premium as a result of price change.

  1. Compute the effective selling price (ESP), and by comparing it to your target price comment on whether it was a good deal.

  1. Compute the overall gain/loss as a result of dealing with the options accounting for a commission of $50 per option traded.

  1. Are you better/worse off as a result of dealing with options as opposed to not dealing with options at all, and why?

  1. Give an example of a futures price that would render your put option out-of-the-money.

Solutions

Expert Solution

a) The Value of option at the time of selling the corn = $2.50-$2.15 =$0.35 (as there is no time value left)

So, Gain per Bu. in options premium = $0.35-$0.2 =$0.15 per Bushel

b) The effective selling price = Current cash price per bushel + Gain from options per Bushel

=$2.15 + $ 0.15

=$2.30 per Bushel

So compared to the target price , it could be achieved even after the cash price was $2.15, so it was a good deal.

(NOTE : The ESP is calculated without taking commission charges of $0.01 per bushel as calculated in part c) below. If the commission charges are taken into account, the ESP is $2.29 per bushel)

c) As one options contract is for 5000 Bushels, there were 3 contracts purchased

Total commissions = $50 per contract * 3 contracts =$150

So, commission paid per Bushel = $150 / 15000 bushel = $0.01 per Bushel

So, the Overall Gain per Bushel = $0.15 per Bushel -$0.01 per Bushel =$0.14 per Bushel from the options contract

Total Gain = $0.14/Bushel * 15000 bushels = $2100

d) We are definitely better off dealing with options rather than not dealing with options at all, as otherwise the price realised would have been only $2.15 per Bushel, but the Put options helped us realise a higher price of $2.29 per Bushel , thereby limiting our losses or maintaining our profit.

e) At the time of selling, if the futures price were above $2.55 and the cash price would have been above $2.50 (basis 5 under) ,the Put option would have been out of money


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