Reference no: EM131925779

Maximum Buying Price - using calls as insurance against rising prices Bill is an Illinois hog producer. Since corn is a major input factor for hog production, its price determines whether Bill will make a profit or loss on his hogs. Knowing his costs pretty well, Bill thinks that he’ll generate positive net returns if he can buy corn for no more than USD 3.50/bu for his next run (group) of hogs. It is January 5, and Bill’s hogs will go on feed (i.e., start to be fed) on February 15. Bill knows that he can obtain insurance against rising corn prices using the options market, but he is not sure how exactly this works. His friend told him that in order to get protection against rising prices he needs to have calls on the March corn futures contract. But does Bill need to buy or sell those options? What strike price does he pick? And will that really work? Bill is uncertain. Can you help him? On January 5, March corn calls trade at different strikes and premiums. Based on the information below, compute for each option the maximum buying price that Bill will have to pay for his corn. Assume that basis is usually USD -0.20 on the March futures on February 15, interest costs are USD 0.01, and commission is USD 0.02. Strike Premium 3.25 3.40 3.55 3.80 3.95 0.43 0.26 0.18 0.13 0.07 Indicate the option that you would recommend to Bill! Explain to Bill why this option is better than the others. Does he need to buy or sell this option to get the desired price protection? Show the cash flows and the net price that Bill will have to pay for his corn on February 15 for the following scenarios Cash corn is at USD 3.91/bu on February 15, March corn futures trade at USD 4.12/bu, and the time value of the call on the March futures is zero. Cash corn is at USD 3.11/bu on February 15, March corn futures trade at USD 3.29/bu, and the time value of the call on the March futures is USD 0.01/bu. Interpret the results! What happens in each of the cases? Did Bill really get price protection?