Options Trading and Agricultural Commodities: A Finance Study

Question 1

Question 1

You own shares in a company and the share price has finally taken off after years of underperformance. You are worried that the share price has got ahead of itself and may face a correction. You don't want to sell the shares, partly because you have become attached to them after all these years, but you also think the prospects are very bright (you know a lot more about the company now than when you bought the shares). Recent results figures have been enthusiastically received by the markets. The shares are up nearly 100% in just over 6 months, with very little in the way of pullbacks. You think that a lot of the recent buyers will want to lock in profits, so you think the share price could easily drop by 15% from the current level.

The share price is currently 248p. You are interested in buying put options on the stock. The nearest expiry options have 45 days until expiry. You decide to buy the 240p put options with that expiry date. The stock has a dividend forthcoming, payable in 20 days and is for 5.6p.

The underlying volatility of the stock is 32.42% and the risk-free rate of interest is 3.0%.

(a)  What is the price of the 240 put option?  (6 marks)

(b)  The share price does fall and with only 20 days to expiry the shares are priced at 218p. Assume the volatility and interest rates are the same. What would be the value of the put option now?  (5 marks)

(c)  Should you sell the put now or wait for expiry? How does the intrinsic and time value for the two put prices, from (a) and (b) answers compare? If someone thought the stock was about to go back up, what price would the 240p exercise price call options be with 2B days left?
(4 marks)

(d)  If you bought the 240 call option and held it to option expiry day and the shares were 242p on option expiry, what would be your profit per contract that you bought?  (3 marks)

(e)  Compare the outcomes from buying the put today and selling with 20 days to go and also holding the put to expiry. How would this compare to a policy of selling the call option at the original time, when the share price was 248p over the same time periods (i.e. 20 days to go and expiry)? Which is the riskier trade and why?  (7 marks)

Question 2

Agricultural Commodities

(a)  Cross hedging is often used by producers and buyers in the agricultural markets to hedge risk. What are the conditions necessary for successful cross hedging, and how would, for example, a sunflower manufacturer (no futures market) go about hedging their production? Explain the process of cross hedging.  (7 marks)

(b)  Describe the risks involved in cross hedging and how would a cross hedger monitor these risks.  (8 marks)

(c)  There are 150 countries that produce bananas, with over 110 million metric tonnes of bananas produced each year. India is the largest producer with over 30 million metric tonnes and China next with 11.7m tonnes (in 2019). Bananas are the most traded fruit in international trade and bananas are the most popular fruit in the world. Bananas are the 5’? largest agricultural product traded.

Total world banana export market is worth $14.7bn (in 2020). The four leading exporting countries are Ecuador, Costa Rica, Philippines and Colombia, accounting for 63% of world exports. Bananas represent one of the most profitable commodities for retailers to sell, yet there is no 
futures market in bananas. What reasons can you think of for there not being an organised futures market in bananas? What are the conditions necessary for a functioning futures market?  (10 marks)

Question 3

(a)  With the onset of the coronavirus pandemic many people were working from home and large numbers became interested in trading stocks. Trading in GameStop in 2D20 and in Robinhood in 2021 were exacerbated by trading in the options markets in these stocks. Describe what was happening here and what dangers the small investors face. Do you think this market for retail investors should be more heavily regulated?
(8 marks)