Logic of hedging with option

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The Logic of Hedging with Option: Morrison Oil and Gas Company's chief financial analyst is Samuel (Sam) Crawford. Sam completed his analysis, suggesting that the investment is indeed a good one for the company, and presented it to the firm's executive committee. The executive committee consists of the firm's CEO, CFO, and COO. The CFO thought Sam's analysis was on target, but the COO and CEO were concerned about the fact that the hedging strategy would not work for the investment. In fact, they wondered why hedging the investment is such a good idea. Sam thought for a second or two before responding and decided how to best explain why the project is a good one and involves hedging the investment cash flows using one-year call option on natural gas. These call options, which have a $13.90 per-MCF strike price, are selling for $1.86 per MCF. Show how selling call options on 50 MCF of gas today and undertaking the invest provides Morrison with a hedged (i.i., risk free) investment.

Reference no: EM13853384

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