Question

6. You decided to hedge the risk of wheat prices with an option. You expected that wheat prices will rise within the next few months because of the shortage of supply caused by drought. The strike price of the option is $310 with a premium of $10. If your expectations were right, and wheat is going for $350 in the market, what is your profit after premium?

A. Buy a put option, the option will be at the money, the payoff after premium is $40

B. Sell a call option, the option will be out of the money, the payoff after premium is $40

C. Sell a call option, the option will be in the money, the payoff after premium is $30

D. Buy a call option, the option will be in the money, the payoff after premium is $30

Answer 1

Call Option is the right to buy the underlying commodity at a specified price on a future date

Put Option is the right to sell the underlying commodity at a specified price on a future date

Since the risk is to be hedged against rising price, call option should be bought

The option will be in the money since market price is higher than the strike price

Payoff after premium = Market price - strike price - premium paid

= 350 - 310 - 10

= $30

Hence, the answer is

D. Buy a call option, the option will be in the money, the payoff after premium is $30