Problem -
The management of HLG, a manufacturer of HVAC equipment, is concerned about potential increases in the price of copper, a key component used in HVAC equipment. Management would like to establish a copper purchase price for their upcoming copper needs in June. It is April. Copper is currently trading in the spot market at a price of $3.08. July copper futures are trading at $3.04 per pound. Historically spot copper prices have traded $0.01 above futures three weeks prior to contract expiration.
Premiums for "at-the-money" July copper call and put options
|
Option Strike Price
|
Call Option Premium
|
Put Option Premium
|
|
$3.00
|
$0.15
|
$0.10
|
|
$3.02
|
$0.14
|
$0.11
|
|
$3.04
|
$0.13
|
$0.12
|
|
$3.06
|
$0.12
|
$0.14
|
|
$3.08
|
$0.11
|
$0.15
|
(a) In order to hedge, what type of option should management purchase?
(b) What intrinsic and time values are associated with the $3.00 option (option consistent with your choice in part a)?
(c) Management looks at the $3.00 and $3.02 options. What price ceilings are associated with these two options?
Management decides to hedge its risk using the $3.00 option. On June 1, three weeks prior to the option's expiration, HLG's production floor is ready to purchase copper in the local market. Copper futures have risen to $3.15. HLG's local copper supplier quotes a price of $3.16. The $3.00 option is trading at $0.17.
(d) If HLG management exercises their option, then offsets their futures position and purchases copper from their local supplier what "realized price" would they face for copper (price inclusive of gains/losses in the futures and options markets)?
(e) If HLG management offsets their option position and purchases copper from their local supplier what "realized price" would they face for copper (price inclusive of gains/losses in the futures and options markets)?
(f) If HLG management had chosen to hedge using futures rather than options what realized price would they face for the copper (price inclusive of gains/losses in the futures and options markets)?