Gold-mining operation can be viewed as call options on gold

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Reference no: EM131882951

Shares in a gold-mining operation can be viewed as call options on gold. If you own a gold mine, you have the right to extract gold from the ground, but you don’t have to do it if mining the gold doesn’t make economic sense. If you think about a gold mine as an option, the underlying asset is gold. The strike price is the cost of extracting the gold, and the option premium is the price of the mine. Buying a gold mine is like buying a call option on gold. Assume that the markets for gold bullion and for gold mining shares are efficient. Option pricing theory suggests that two of the following statements are true and one is false. In each of the statements below, assume that all other factors are held constant except for the factor mentioned in the statement. Please explain,

(i) shares of gold mining companies should move more in percentage terms than gold bullion prices (i.e., if the price of gold goes up 10%, the price of the shares will go up more than 10%)

(ii) movements in the prices of gold mining shares should foreshadow future movements in the price of gold

(iii) holding the current price of gold fixed, an increase in the price of gold mining shares will probably be followed by an increase in the volatility of the price of gold.

Reference no: EM131882951

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