Question
Option Suppose that you own the option to extract 5,000 barrels of oil at a cost of $58/barrel. The one year forward price for a
Option Suppose that you own the option to extract 5,000 barrels of oil at a cost of $58/barrel. The one year forward price for a barrel of oil is $76/bbl. You can lock in that price today or wait. If you wait the price of a barrel of oil could be as high as $100 or as low as $40 and the extraction costs will stay at $58/barrel next year. Assume no discounting for both parts of this problem (or assume the discount rate is 0% What is the risk-neutral or implied probability that the price of a barrel of oil is $100 next year? Should you wait or lock in the price today? Why?
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