2. You are a producer of gold, and have expenses of 800 per ounce of gold produc

Question

2. You are a producer of gold, and have expenses of 800 per ounce of gold produced Assume that the cost of all other production-related expenses is negligible, and that you will be able to sell all gold produced at the market price. In 1 year, the market price of gold will be 1 of 3 possible prices, corresponding to the following probability table Gold Price in 1-year 750 per ounce 850 per ounce 950 per ounce Probability 0.2 0.3 0.5 You hedge the price of gold by buying a 1-year put option with an exercise price of 900 per ounce. The option costs 100 per ounce now, and the continuously compounded interest rate is 6%. Calculate your expected 1-year profit of your total position

Explanation / Answer

Profit on a put option=max(Exercise price-spot price,0)-put premium

Expected Profit of total position=0.2*(max(900-750,0)-50)+0.3*(max(900-850,0)+50)+0.5*(max(900-950,0)+150)-100*e^(6%*1)
=18.81634535

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