Question
Consider a call option on the price of a gallon of oil with a strike price of $20 per gallon that expires in 30 days.
Consider a call option on the price of a gallon of oil with a strike price of $20 per gallon that expires in 30 days. Assume that UPS anticipates making a substantial purchase of oil (5 million gallons) in 30 days. Further, UPSs profits are negatively related to the price of oil. That is, the higher the cost of oil, the lower is UPSs profits. If the current price of oil is $19 per gallon, under what circumstances will UPS be willing to purchase the call option? Graph the net payoff of the option to UPS if the price of the option is $3. If each option is based on one million gallons of oil, how many options must UPS buy to completely hedge its exposure to increasing oil prices? How much would this cost (Hint: the answer is not $15)?
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