Consider, again, National Petroleum from Example 21.3 in Chapter 21. In addition to the forward contracts described in Example 21.3, National Petroleum also can buy (put) options that give them the right to sell the oil in one, two, or three years at an exercise price of $20 per barrel.

The one-year option costs $2.00, the two-year option $3.00, and the three-year option $3.50 per barrel. What should National Petroleum do to eliminate the possibility of financial distress and still have money to fund new exploration in the event that oil prices increase?

AppendixLO1