45 lines
3.8 KiB
Plaintext
45 lines
3.8 KiB
Plaintext
555
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OPTION TrAdINg STrATegIeS
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2. buy spot gold. The jeweler can buy spot gold and store it until August. In this case, he locks
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in a purchase price of $1,198.90/oz plus carrying costs (interest, storage, and insurance). This
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approach eliminates price risk, but also removes the potential of benefiting from any possible
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price decline.
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3. buy gold futures. The jeweler can purchase one contract of August gold futures, thereby
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locking in a price of $1,200/oz. The higher price of gold futures vis-à-vis spot gold reflects the
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fact that futures embed carrying costs. Insofar as the price spread between futures and spot gold
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will be closely related to the magnitude of carrying costs, the advantages and disadvantages of
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this approach will be very similar to those discussed in the above strategy.
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4. buy an at-the-money call. Instead of purchasing spot gold or gold futures, the jeweler could
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instead buy an August $1,200 gold futures call at a premium of $38.80/oz. The disadvantage of
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this approach is that if prices advance the jeweler locks in a higher purchase price: $1,238.80/
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oz. However, by purchasing the call, the jeweler retains the potential for a substantially lower
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purchase price in the event of a sharp interim price decline. Thus, if, for example, spot prices
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declined to $1,050/oz by the time of the option expiration, the jeweler’s purchase price would
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be reduced to $1,088.80/oz (the spot gold price plus the option premium).
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6 In effect, the pur-
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chase of the call can be viewed as a form of price risk insurance, with the cost of this insurance
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equal to the “premium.”
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7
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5. buy an out-of-the-money call. As an example, the jeweler could purchase an August
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$1,300 gold futures call at a premium of $9.10/oz. In this case, the jeweler forgoes protection
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against moderate price advances in exchange for reducing the premium costs. Thus, the jeweler
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assures he will have to pay no more than $1,309.10/oz. The cost of this price protection is $910
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as opposed to the $3,880 premium for the at-the-money call. In a sense, the purchase of the
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out-of-the-money call can be thought of as a price risk insurance policy with a “deductible.” As
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in the case of purchasing an at-the-money call, the jeweler would retain the potential of benefit-
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ing from any interim price decline.
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As should be clear from the above discussion, options meaningfully expand the range of choices
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open to the hedger. As was the case for speculative applications, the choice of an optimal strategy will
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depend on the trader’s (hedger’s) individual expectations and preferences. It should be stressed that
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this section is only intended as an introduction to the concept of using options for hedging. A compre-
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hensive review of hedging strategies would require a far more extensive discussion.
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6 T echnically speaking, since gold futures options expire before the start of the contract month, the effective
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purchase price would be raised by the amount of carrying costs for the remaining weeks until August.
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7 The use of futures for hedging is also often described as “insurance.” However, in this context, the term is
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misapplied. In standard application, the term insurance implies protection against a catastrophic event for a cost
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that is small relative to the potential loss that is being insured. In using futures for hedging, the potential cost is
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equivalent to the loss protection. For example, if the jeweler buys gold futures, he will protect himself against
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a $10,000 increase in purchase cost if prices increase by $100/oz, but he will also realize a $10,000 loss on
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his hedge if prices decline by $100/oz. In this sense, the use of the call for hedging comes much closer to the
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standard concept of insurance: the magnitude of the potential loss being insured is much greater than the cost
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of the insurance. |