Please Check A-G & Help With H-M! There is no contract size!
PROBLEM 6 (50 points) Suppose that you know today that you will be purchasing a pen of segregate early weaned pigs a few months from now and that you will need 10,000 bushels of corn for feeding purposes. Additionally, you know that given the current corn cash price of $2.35/bu., you have the potential to feed-out these pigs for a profit. However, you are concerned that the corn price may move against you before you purchase the hogs. You purchase a $2.55/bu. call option for $0.30/bu. and expect the basis to be $0.05 under. When you are ready to purchase the hogs and corn to make feed, the cash and futures prices have increased to $3.00/bu. and $3.05/bu., respectively. Assuming zero time value and that the broker charges a commission of $50 per option traded, answer the questions below. a. What are you trying to protect against? I am trying to protect against a rise in the price of corn in a few months from now. Since I am a buyer of corn, this means I could potentially pay a higher price in the future. b. What do you call the price of $2.55/bu. of a call option? The price of $2.55/bu is called the exercise price or strike price. c. What do you call the price of $0.30/bu.? The price of $0.30/bu is called the option premium. d. Is your call option in-the-money/at-the-money/out-of-the-money after the price changes, and why? The call option is in-the-money as the strike price is less than the spot price after the price change. e. What is the number of option contracts needed to fully protect the purchase of 10,000 bushels? One futures contract is for 5,000 bushels (CBOT/CBOE) # of call option contracts= 10,000 Bushels/5,000 Bushels/contract=2 contracts f. What is the total amount that you have to pay to purchase the necessary call options? Price Paid= Commission Charges + Premium Charges = $50/contract * 2 contracts + $0.30/bushel*10,000 bushels =$100 +$3,000= $3,100 Basis=Spot Price- Futures Price $3.00-$3.05= -$0.05 h. Compute the target price. i. Compute the gain/loss per bu. you have earned on options in terms of the premium as a result of price change. j. Compute the effective buying price (EBP), and by comparing it to your target price comment on whether it was a good deal. Effective Selling Price= Current cash price per bushel + Gain from options per bushel k. Compute the overall gain/loss as a result of dealing with the options. 1. Are you better/worse off as a result of dealing with options as opposed to not dealing with options at all, and why? m. Give an example of a futures price that would render your call option out-of-the- money
