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a) Today you have purchased one tonne of commodity A for price S. You are concerned that the price per tonne of commodity A is
a) Today you have purchased one tonne of commodity A for price S. You are concerned that the price per tonne of commodity A is going to fall over the next few months and wish to protect against this eventuality. You decide to use a put option written on commodity A, with strike price S and 3 months to maturity, to deliver this protection. Show, analytically and graphically, how the put option, when held in conjunction with the position in the underlying commodity, helps you achieve your goal. Be clear about how the option premium, p, affects your profits. [Note: when computing the profits from your combination of the option and the underlying, there is no need to account for the time value of money] [6 marks] b) You wish to arrange a forward purchase of 1 unit of commodity B with delivery in 3 months. The spot price of B is 350 per unit and the stated annual 3-month interest rate is 4%. If the commodity costs 10 per quarter to store (payable at the end of the quarter) develop an arbitrage argument which allows you to work out the delivery price you should be prepared to pay in 3 months. [6 marks]
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