Assume that you will need 1,000 Barrels of oil (you are a finance manager at delta, one month from today. The current price of oil is $40.00 / barrel. You expect that the future spot price/barrel could be either, $35.00, $45.00, or $55.00 with equal probability. The 1 month forward rate oil is $48.00 / Barrel. The cost on an at-the-money Call option on oil is $4.00 per barrel. The cost on an at-the-money Put option on oil is $3.00 per barrel. Compute the Net cost of oil under each of the following scenarios.

a)Net Final Cost /barrel of oil if you used a Forward contract

b)Net Final Cost /barrel of oil if you used Call options to hedge

c)Net Final Cost /barrel of oil if you used Put options to hedge

d)Net Final Cost /barrel of oil if you did not hedge, i.e. buy in open market after 1 month.

e)What should your optimal strategy should be and why.

Summarize your answers in the table below;

Strategy

Spot Price in 1 month = $35.00

Spot Price in 1 month = $45.00

Spot Price in 1 month = $55.00

a) Using Forward Contract (Specify one) Long or Short

(i) Cost from Oil

(ii) Profit /Loss on Forward

(iii = i +ii) Net Cost

(with Forward hedging)

b) Using Call options Contract (Specify) Long or Short

(i) Cost from Oil

(ii) Profit /Loss on Options

(iii = i +ii) Net Cost

(with Options hedging)

c) Using Put options Contract (Specify) Long or Short

(i) Cost from Oil

(ii) Profit /Loss on Options

(iii = i +ii) Net Cost

(with Options hedging)

d) No Hedge

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