Series 3 hedging

Question

1.       An investor is long March wheat at 446. The contract has increased in value to 459. If the investor is concerned that the demand for wheat may not meet estimates and would like to protect against a decline in the contract, yet still be able to realize any additional appreciation they should:

A. Buy puts at 500

B. Sell calls at 500

C. Sell calls at 500 and buy a 450 puts

D. Buy puts at 450

 

Answer 1

The investor wants to protect against a decline in the price of wheat while still being able to benefit from further appreciation. The best way to do this is by buying a put option, which provides downside protection while keeping the upside open.

D. Buy puts at 450 – This is the best answer because buying a put at 450 allows the investor to sell the contract at 450 if the price drops, providing protection while still allowing them to benefit from any additional gains above the current price of 459.