Question

Gold is currently trading for about 1,650 per ounce. You are considering 3 ways of taking a short position on gold: (i) sell 100 ounces of gold short, (ii) take a short position in 1000 gold futures (October 2020), (iii) buy a futures put options on 1000 gold futures at K=1650 (October 2020).

(a) If you enter the above positions when gold equals 1,650, compare the dollars in profit from the three ways of betting against the price of gold if gold ends up at the following prices at time t: 1400, 1450, 1500, 1550, 1600, 1650, 1700, 1750, 1800, 1850 (Note: you should assume the price of one futures put option is $10).

(b) Draw a diagram showing the profits for each position for each price of gold.

(c) Which option has the lowest risk? Explain

Answer 1

A) Current Market Price = $1650 per ounce

Gold @ Expiry	1400	1450	1500	1550	1600	1650	1700	1750	1800	1850
Sell 100 ounces of gold	+$25,000	+$20,000	+$15,000	+$10,000	+$5000	0	-$5000	-$10,000	-$15,000	-$20,000
Take a short position in 1000 gold futures	+$250,000	+$200,000	+$150,000	+$100,000	+$50,000	0	-$50,000	-$100,000	-$150,000	-$200,000
Buy a put options on 1000 gold futures at K=1650, P=$10	+$240,000	+$190,000	+$140,000	+$90,000	+$40,000	-$10,000	-$10,000	-$10,000	-$10,000	-$10,000

B)

C) Clearly visible, the risk in buying the put option is least (it has a max risk of $10,000).