Futures and Options as Hedging Alternatives Companies seeking to hedge future purchases or revenue flows can often choose between futures contracts and option contracts. Sami Corp. projects purchasing 100 tons of a commodity in three months: its current spot price is $700/ton and the six-month futures price is $7l0/ton. Ninety-one day call options on the commodity at the money sell for $50.
Assume that Sami subsequently signs purchase orders for 100 tons to be delivered in three months at the then-current spot price, and hedges those firm commitments with six-month futures contracts requiring a $20,000 margin deposit. At the end of the three-month period, when the futures price is $690/ton, Sami closes its futures position and takes delivery of the 100 tons at the spot price of $682/ton.
Required
a. What factors should Sami consider when deciding between hedging with futures and options?
b. Prepare summary journal entries to record all the events surrounding the firm commitment, the futures hedge and the eventual purchase of the 100 tons at the $682/ton spot price.
c. Suppose that Sami does not sign purchase orders and instead uses option contracts to hedge its anticipated purchases, designating the options' intrinsic values as the hedge instrument. The option contracts remain out of the money and expire when Sami makes the spot market purchase at $682/ton. Prepare summary journal entries to record these events.
d. Compute the cash gain or loss from hedging versus not hedging in parts b and c.