Holly, a speculator, expects interest rates to decline in the near future. Thus, she purchases a call option on interest rate futures with an exercise price of 92-10. The premium on the call option is 2-24. Just before the expiration date, the price of Treasury bond futures is 97-14. At this time, Holly decides to exercise the option and closes out the position by selling an identical futures contract.
1.) Holly's net gain from this strategy is:
a.) -2687.50
b.) 2687.50
c.) 2375.00
d.) 7437.50
e.) none of the above
2.) Insurers, Inc., an insurance company, sold the call option purchased by Holly. Insurers' net gain from selling the call option to Holly is:
a.) -2687.50
b.) 2687.50
c.) 2375.00
d.) 7437.50
e.) none of the above
To determine Holly's net gain from this strategy and Insurers, Inc.'s net gain from selling the call option, we need to calculate the payoff for both parties.
1.) Holly's Net Gain:
To calculate Holly's net gain, we need to consider the exercise price, premium paid, and the price of Treasury bond futures at the expiration date.
The exercise price mentioned is 92-10, which means it is 92.3125 in decimal form.
The premium paid is 2-24, which means it is 2.75 in decimal form.
The price of Treasury bond futures at expiration is 97-14, which means it is 97.4375 in decimal form.
Since Holly purchased a call option, she has the right to buy the futures contract at the exercise price. To calculate her gain, we need to subtract the exercise price from the price of Treasury bond futures at expiration.
Gain = Price at Expiration - Exercise Price = 97.4375 - 92.3125 = 5.125
However, Holly paid a premium for the call option of 2.75, so we need to subtract the premium from the gain to get her net gain.
Net Gain = Gain - Premium = 5.125 - 2.75 = 2.375
Therefore, Holly's net gain from this strategy is 2.375, which corresponds to option (c) 2375.00.
2.) Insurers, Inc.'s Net Gain:
Insurers, Inc. sold the call option to Holly, so their net gain would be the premium received from the sale of the option.
Therefore, Insurers, Inc.'s net gain from selling the call option to Holly is 2.75, which corresponds to option (c) 2375.00.