Question

The manager of Vueling is worried about a possible increase in crude oil price volatility. Under this scenario the uncertainty regarding operational costs of the firm would rise. What strategy with options must Vueling Airlines follow to be hedged against this possibility?

Select one:

a. Buy put options on the oil crude

b. Sell a future contract on the oil crude

c.
Buy a straddle written on crude oil.

d. Sell a straddle written on crude oil

Answer 1

If the manager is worried about the increasing prices, he will be hedging through buying a straddle which will help him to gain through the volatility as straddle consists of a call option and put option of the same strike price and any volatility on the way upside will help him gain through the changes in oil price either on the upside or on the downside.

If the amount of crude oil change is more than the amount of the premium paid on the both call and put option the company will gain through it.

Volatility increases the value of both call option and put option so it will always be better to buy both of them which would be done through buying a straddle.

Correct answer is option ( C).