Question:

In January, Delta airlines is planning to buy 100,000 gallons of jet fuel in each ofthe months of June and July at the cash market price at JFK airport near New York. The current spot price of jet fuel is $2 per gallon.

a). Explain how in January, Delta airlines can use futures contracts on jet fuel to hedge its future purchases (of jet fuel) and what will happen if the spot price of jet fuel turns out to be $3 per gallon in June and July.

b). Explain how in January, Delta airlines can set a maximum effective price it pays for jet fuel of around $2.5.Explain the outcomes if the spot price of jet fuel is either $3 or $1 ( in both June and July).

c). Suppose in January Delta airlines also sells a put option with a strike price of $1.5. Explain the outcomes if the spot price of jet fuel is either $3 or $1 ( in both June and July).

d). Briefly explain how you would incorporate the cost of the calls and puts into your analysis.

Make any reasonable assumptions to give a clear logical answer.

You may use illustrative figures, algebra, equations and diagrams as you see fit.