6. Hedging price risk with options Aa Aa A short hedge helps protect the produce

Question

6. Hedging price risk with options Aa Aa A short hedge helps protect the producer to sell a commodity against falling prices. But once the producer places a hedge on falling prices, it also restricts its potential to benefit from an increase in price. To get protection from falling prices and benefit from rising prices, the producer can take advantage of hedging its price risk using options. Options can be considered a form of insurance that helps protect the underlying asset against changes in price. Just ke insurance,the holder has to pay a premium for the option. If the underlying asset is a futures contract, a at a fixed price. If the option can be exercised only at expiration, the option will be classified as option will give the holder the right to buy a futures contract Consider the case of Wellington Beans: Wellington Beans is one of the leading producers of soybeans. To fulfill an upcoming contract commitment due in 60 days, the company bought soybean futures at a price of 1,374 cents per bushel; it also placed a short hedge to protect itself from a decline in the prices of soybean in 60 days by offsetting the losses in the cash market with the gains in the futures market. On the delivery date, if the spot price of soybeans increased to 1,786 cents per bushel, Wellington Beans would have to sell soybeans to its customer at the price of Wellington Beans managers want to both protect the company's sales from potential declining prices and gain from any possible increase in soybean prices. To accomplish this, the managers purchased put options and soybean futures (with the soybean futures contracts serving as the underlying asset). The option gives the company the right to sell its soybeans at an exercise price of 1,580 cents per bushel in 60 days. The price of the option is 275 cents per bushel

Explanation / Answer

call
European
1374

1374
worthless/0, loss/premium (max(1580-1786,0)=0
1099 =1374-275=1099

1374
481 (max(1580-1099,0)=481
206 =481-275=206
1168 =1374-206

Related Questions

Navigate

• Browse (All)
• Browse 6
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.