Question

b) Given that you have bought a Call Option to purchase Brent Blend crude at a Strike Price of $49/bbl for a volume of 200,000 barrels. You have paid a premium of $2.50/bbl to the counterparty of the contract. During the month in which the option is exercisable, Brent Blend is trading at $52.46/bbl. Critically evaluate whether you would exercise your Call Option and make a valid judgement based on numerical calculations.

Answer 1

Call option is a right to purchase. If exercise price is less that spot price at maturity, you will have a positive payoff because you have right to purhcase at lower exercise price and sell it in higher market price. If the spot price at maturity is less than exercise price, then option is not exercised as their will be loss from option. The loss will be equal to premium paid in this case.

Pay off from call option = Max[S_r - X,0]

where S_T = Spot price at maturity/expiry and X = Strike Price/Exercise Price

Pay off/bbl = Max[52.46 - 49,0] = 3.46

Profit = Payoff/bbl - Premium Paid/bbl

= 3.46 - 2.50 = 0.96/bbl

Clearly, Brent Blude is making a profit of $.96/bbl and should exercise the option.

Total Profit = Number of barrels contracted*Profit/bbl = 200,000*.96 = $192,000

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