4.8. Hekinan Corporation has bought 4000 barrels of Brent crude oil $112.63 a ba

Question

4.8. Hekinan Corporation has bought 4000 barrels of Brent crude oil $112.63 a barrel. It has sold call options on 2000 barrels of oil, with exercise price $110, for $5.50 each; and options on 1000 barrels of oil, exercise price $115, for $1.80 each. All options will expire after 35 days and then Hekinan will liquidate this position. Hekinan expects the price of Brent crude after 35 days to be $114.50 a barrel. It uses 10% as the discount rate, with continuous compounding. Calculate the following the initial investment ($437,720), the final liquidation value ($449,000) and NPV of this investment ($6995.10). Show solutions.

Explanation / Answer

The initial investment will be barrels of oil bougt - option premium received.

= (4000× 112.63) - ( 5.5×2000) - (1.8 × 1000)

450520 - 11000 - 1800 = 437720$

At the end of 35 days price is 114.50, so only call option of price 110 will be executed by its buyers.

(2000×114.5) +2000×(110) = 449,000$

PV of 449,000 is 449000 × e ^(-0.1× 35/365) = 444,715.09

NPV is -437,720 + 444,715.09 = 6995.10$

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