FIN 3480. Homework #3 Energy Hedging You are an oil producer. (You pull oil out
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FIN 3480. Homework #3 Energy Hedging You are an oil producer. (You pull oil out of the ground and sell it to an oil refinery) Today, you estimate your oil production be as follows: Jan 2018 10,000 barrels Feb 2018 12,000 barrels Mar 2018 15,000 barrels You wish to hedge your production The current oil pricing curve looks like this: Jan $52.00 per barrel Feb $53.25 per barrel Mar $54.55 per barrel You elect to hedge Jan and Feb by a straight swap (floating for fixed rate) and Mar by purchasing an option. The premium for a Mar18 option Call is: $1,000 per 1000 barrels. The premium for a Mar18 option Put is: $500 per 100 barrels Question: On Jan 31, 2018 the spot price of a barrel of oil is $48.25. What is your net dollar settlement of the Jan hedge? 1. On Feb 28, 2018 the spot price of a barrel of oil is $59.45. What is your net dollar settlement of the Feb hedge contract? 2. On Mar 31, 2018 the spot price of a barrel of oil drops to $38.75. Do you exercise your option? What is the net dollar settlement of the option if exercised? 3.Explanation / Answer
Estimate of oil production is as follows : Jan,2018 10,000 barrels Feb,2018 12,000 barrels Mar,2018 15,000 barrels The current oil pricing curve per barrel is: Jan $ 52.00 per Barrel Feb $53.25 per barrel Mar $54.55 per barrel Here Jan and feb by a Straight Swap( floating for fixed rate) and Mar by purchasing an option : a) The premium for a Mar ,2018 option call is : $1,000 per 1,000 barrels b) The premium for a Mar ,2018 option put is : $5,00 per 1,00 barrels 1. on jan,2018 the spot price of a barrel of oil is $48.25 then net dollar settlement of the jan hedge is net dollar settlement = Spot price - Strike price Spot price 48.25 Strike Price 52 net dollar settlement -3.75 per barrel Total Net loss dollar settlement 10000*$3.75 (37,500.00) 2. on Feb,2018 the spot price of a barrel of oil is $59.45 then net dollar settlement of the Feb hedge is Spot price 59.45 Strike Price 53.25 net dollar settlement 6.2 per barrel Total Net profit dollar settlement 10000*$6.2 62,000.00 3. on Mar,2018 the spot price of a barrel of oil is $38.75 then net dollar settlement of the Mar hedge is Amount $ Strike price = $54.55 total strike price = 15000*$54.55 818250 The premium on option call 1000 The premium on option put 500 Total 819750 option put is a right not obligation . But the option call is a right A put option is said to have intrinsic value when the underlying instrument has a spot price (S) below the option's strike price (K). Upon exercise, a put option is valued at K-S if it is "in- the-money", otherwise its value is zero. so total strike price =818250+1000 819,250 Spot price 15000* $38.75 581,250 Strike Price 819,250 net loss dollar settlement (238,000)
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