Exploring Payoffs from Options Trading in Oil Market
What is the scenario of options trading in the oil market?
A financial manager buys call options on 26,000 barrels of oil with an exercise price of $111 per barrel and simultaneously sells a put option on 26,000 barrels of oil with the same exercise price of $111 per barrel. What are her payoffs per barrel if oil prices are $106, $107, $111, $115, and $116?
Answer:
The payoffs per barrel for the financial manager in the given scenario are as follows:
- For oil price of $106: $5 profit from call option, $111 profit from put option
- For oil price of $107: $4 profit from call option, $111 profit from put option
- For oil price of $111: $0 profit from call option, $0 profit from put option
- For oil price of $115: $4 profit from call option, $0 profit from put option
- For oil price of $116: $5 profit from call option, $0 profit from put option
Options trading in the oil market involves the buying of call options and selling of put options with a specific exercise price. In this scenario, the financial manager has positioned herself to benefit from different oil price movements.
When the oil price is lower than the exercise price of $111, the call option is not profitable while the put option yields profits. As the oil price increases beyond $111, the call option starts to generate profits while the put option becomes less profitable.
By understanding how the payoffs per barrel change based on varying oil prices, the financial manager can make informed decisions on managing her options portfolio in the volatile oil market.