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A refinery will buy 10,000 barrels of oil in March. The forward price for delivery in March is $45.5/barrel, and the prices of March call and put options with prices $46/barrel are $2.5 and $3 respectively. Assume that each forward and option contract is for 1000 barrels
a. Should the refinery buy or sell forwards to hedge their exposure? How many contracts should the firm trade? Draw a payoff diagram showing how the firm's payoff change with the spot price in March for their underlying position, the forward contract, and their net position.
b. Suppose the refinery trades half as many contracts as you assumed in part (a). Redraw the payoff diagrams and explain the intuition
c. If the refinery hedges using options, should it trade calls or puts? Buy or sell? How many contracts? Draw a payoff diagram showing how the firm's purchase price (with and without hedging) varies with the spot price of oil in March. The payoff diagram should take into account the premium (but ignore the time value of money)
Finance is about Gunns Ltd, a company in dealing with forestry products in Australia. The company has also been listed in Australian Stock Exchange. As many companies producing forestry products, even Gunns Ltd is facing various problems. Due to the ..
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