2. [15 points] It is March 6. Options Inc. is a cocoa distributor in Canada. Suppose Options Inc. has just entered into a contract with a chocolate processing firm in Ontario to sell 2,000 metric tons of cocoa, to be delivered on July 6. The sale price is agreed by both parties to be based on the market price of cocoa on the day of delivery. The July cocoa futures is trading at US$ 2,258 per metric ton with the expected adjusted basis of C$55.41 per metric ton under the futures, and the exchange rate is 0.74 US$/C$. If Options Inc. is forward contracting, it signs a contract with the processor at C$3,000 per metric ton. Another alternative is to buy the July cocoa futures PUT options with a US$3,000 per metric ton strike price for a premium of US$750 per metric ton. Market conditions when cocoa is bought on July 6 are: July futures is trading at US$2,300 per metric ton, the July Canadian dollar is trading at US$0.75 per C$, and the adjusted basis is C$55.41 per metric ton under the futures, as expected. Contract size is 10 metric tons. a. Calculate the intrinsic and time values of the PUT option on March 6 (in C$ per metric ton). Calculate the intrinsic value of the PUT option on July 6 (in C$ per metric ton). b. On separate diagrams, draw the patterns of profits or losses (in C$) for the short futures position and for the long PUT option position, as a function of the futures price. Label your diagrams appropriately. c. Calculate the net cash price for each marketing strategy on July 6: (i) hedge with a forward contract, (ii) hedge with futures or (iii) hedge with PUT options. For (ii) and (iii), include a calculation of the net profit for the futures or option position. d. If Options Inc. knew with perfect foresight what would happen to prices in July, which contract would you recommend: (i) hedge with a forward contract, (ii) hedge with futures or (iii) hedge with PUT options? Why? 2. [15 points] It is March 6. Options Inc. is a cocoa distributor in Canada. Suppose Options Inc. has just entered into a contract with a chocolate processing firm in Ontario to sell 2,000 metric tons of cocoa, to be delivered on July 6. The sale price is agreed by both parties to be based on the market price of cocoa on the day of delivery. The July cocoa futures is trading at US$ 2,258 per metric ton with the expected adjusted basis of C$55.41 per metric ton under the futures, and the exchange rate is 0.74 US$/C$. If Options Inc. is forward contracting, it signs a contract with the processor at C$3,000 per metric ton. Another alternative is to buy the July cocoa futures PUT options with a US$3,000 per metric ton strike price for a premium of US$750 per metric ton. Market conditions when cocoa is bought on July 6 are: July futures is trading at US$2,300 per metric ton, the July Canadian dollar is trading at US$0.75 per C$, and the adjusted basis is C$55.41 per metric ton under the futures, as expected. Contract size is 10 metric tons. a. Calculate the intrinsic and time values of the PUT option on March 6 (in C$ per metric ton). Calculate the intrinsic value of the PUT option on July 6 (in C$ per metric ton). b. On separate diagrams, draw the patterns of profits or losses (in C$) for the short futures position and for the long PUT option position, as a function of the futures price. Label your diagrams appropriately. c. Calculate the net cash price for each marketing strategy on July 6: (i) hedge with a forward contract, (ii) hedge with futures or (iii) hedge with PUT options. For (ii) and (iii), include a calculation of the net profit for the futures or option position. d. If Options Inc. knew with perfect foresight what would happen to prices in July, which contract would you recommend: (i) hedge with a forward contract, (ii) hedge with futures or (iii) hedge with PUT options? Why
