You are employed by the Treasurers office of a major airline company. Your assignment is to analyze possible hedging strategies using oil price futures.

Todays oil price is $55/barrel.

First, consider a European call option on oil price with a maturity of 1 year and a strike of $60. As in the class, the payoff does not count the premium of the option.

1. a) What is the payoff for the call option if the oil price stays at $55?

2. b) What is the payoff for the call option if the oil price increases to $65?

Next, consider a European put option on oil price with a maturity of 1 year and a strike of $60.

c) What is the payoff for the put option if the oil price stays at $55?

d) What is the payoff for the put option if the oil price increases to $65?

Lastly, we buy both the call and the put options as described above. This is called a straddle strategy.

5. e) What is the payoff of this strategy if the oil price stays at $55?

6. f) What is the payoff of this strategy if the oil price increases to $65?

7. g) What is the lowest payoff of this strategy? At what oil price is the lowest payoff obtained?