Reference no: EM133313033

Risk Management with Options. Newmont Mining is the largest gold-mining company in the US. While other companies mine a wide portfolio of metals, Newmont is nearly a "pure play" in the gold sector. As such, they have a considerable exposure to fluctuation in the price of gold, so have a real interest in managing the effect of changes in gold prices on their earnings. Suppose Newmont is considering a range of options strategies to help manage their risk. It is currently June 1, and the December futures contract is trading for $1,200 per ounce. Each option contract controls 100 ounces of gold (one futures contract). Use this information to answer the following questions.

1. Suppose Newmont would like to use a put hedge on the December futures contract. They decide to use an at-the-money option (strike price = $1,200) and pay a $20 premium for doing so. Describe what the payoff diagram for this strategy would look like by explaining what happens to the net value of their position if the futures contract either falls to $1,100 per ounce, or rises to $1,300 per ounce.

2. Is the put hedge strategy in part a better or worse than a straight futures hedge? Explain your reasoning.

3. Instead of a put hedge, Newmont is also considering a covered call strategy as they do not think the $1,200 price is sufficient to make their profit goals. If a call on the December contract (strike = $1,200) is trading for $30, explain how they can manage the risk of their cash position using this strategy. Show again by calculating the net value of their position if the futures price falls to $1,100 per ounce, and rises to $1,300 per ounce.