Question 5 (7.5 points)

We are in mid-December 2019, and the current price of March 2020 corn futures is $3.80/bu. Farmer Jones still has about 50,000 bushels of corn left to harvest (the winter started really badly for farmers), and he wants to market it in March. He decides to hedge using the following strategy:

(i) buy a March 2020 put on (March) corn futures with an exercise price of $3.50 per bushel.

(ii) simultaneously sell a March 2020 call on (March) corn futures with an exercise price of $4.10 per bushel. Both options are European.

(a) (3.5 points) Graph Farmer Jone's expected payoff at option expiration as a function of the March corn futures price at that time. (If you prefer, you may establish a table with the payoffs instead of a graph.)

(b) (1.5 point) What is this strategy functionally equivalent to?

Can you explain how to correctly solve Question 5?