Would the miller be better off exercising the option

Reference no: EM133616848

Problem

A miller wants to establish a maximum buying price for wheat. It is May 19th and he needs to buy the product on August 15th. He also wants to be able to take advantage of potentially lower wheat prices between May and August. To do this, he buys one $6.00/bu September Wheat Call for $0.50 when September futures trade at $6.35/bu. The expected local basis in August is $0.05/bu above futures.

Question A. On August 15th, when the miller buys wheat, the basis is $0.25/bu above futures, which trade at $6.55/bu. The $6.00/bu September Call Wheat is trading at $0.65. What is the time value of the $6.00/bu September Wheat Call on August 15th? If the TV was $0.15 on May 19th, did the TV increase or decrease?

Question B. Would the miller be better off exercising the option or offsetting his position by selling the Long Call back? Why?

Question C. Instead, assume the price of the contract in August was $5.95/bu? What should the miller do in this circumstance? What is the actual buying price? Why?

Reference no: EM133616848

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