Question

A firm which plans to buy oil might anticipate a period of market volatility and wish...

A firm which plans to buy oil might anticipate a period of market volatility and wish to protect its expense against price fluctuations. The firm should:

A. enters a long position in oil futures or purchase a call option on oil.

B. enters a long position in oil futures or purchases a put option on oil.

C. enters a short position in oil futures or purchase a call option on oil.

D. enters a short position in oil futures or purchases a put option on oil.

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Answer #1

Correct answer: D. enters a short position in oil futures or purchase a put option on oil

Current position in oil = BUY

Thus, To hedge against loss due to price fluctuations we need to take opposite position in futures or option.

Short Future position is contract to sell the underlying asset i.e oil at a fixed price on maturity.

Put option is contract which give a right to sell underlying asset at fixed price i.e strike price on maturity.

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