Question

You need a barrel of oil in six months. You could either buy the oil today and keep it for a month,
wait and buy the oil next month when you need it, you could enter into a futures contract to buy oil at
the current futures price $64 per barrel, or you can pay $4 for a call option that gives you the right to
buy oil for $60. The current spot price is $61 and the risk free rate is 1%, and carrying costs are $2. If the
price ends up being $67 next month, then you should have

a) Waited to buy the oil
b) Entered into a futures contract
c) Bought a call option
d) Buy the oil today and store it for a month.

Answer 1

A) If one had wait to buy then he would have incurr loss of 7$ per barrel

B) Forward contract gives right to buy underlying asset at specified price at expiry

Thus profit per barrel = 67$-64$ =3$

C) Call option: It gives right to buy the asset at strike price at expiry

Profit on exercise of option = 67$-60 = 7$

Less: premium paid = 4$

Net profit = 3$

D) If oil was bought today

then profit = 67-61 = 6$

Less: opportunity loss(61$*1%) = (0.61) [ assuming interest rate stated is per month]

Carrying cost = (2)

Net profit =3.39$'

Thus ans d) Buy the oil today and store it for a month.