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T & M Engineering limited uses huge quantities of crude oil for their operations. Currently, a barrier of crude oil is $50 but the company expects the price to rise significantly over the next few months. The company decides to use options to hedge against increases in crude price, which could have significant impact on its cash flows. The strike price for a barrier of crude oil for three months is $53. The premium for entering into the options contract is estimated at $5 per barrier of crude oil. The company decides to enter into an options contract with a writer. Use the information above to answer the questions bellows

i. Should the company buy a call on crude oil or a put on crude oil? Explain

ii. Draw the payoff diagram depicting the information

iii. If the spot price of a barrier of crude oil at the end of the three months maturity is $59, will the option be exercised? What will be the profit/loss?

iv. Assuming the spot price at the end of three months maturity $49, what will be the profit/loss for the company assuming it enters into the option contract involving 5000 barriers of crude oil?

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Financial Management, Finance

Category:- Financial Management
Reference No.:- M92712449

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