To capitalize on your expectation of a 10% gold price appreciation, you consider buying futures or option contracts to speculate. The spot price of gold is $400. Near-delivery futures contracts are quoted at $410 per ounce with a margin of $1,000 per contract of 100 ounces. Call options on gold are quoted with the same delivery date. A call with an exercise price of $400 costs $20 per ounce. The rate of return on your speculation will be the return on your invested capital, which is the initial margin for futures and the option premium for options.
a. Based on your expectation of a 10% rise in gold price, what is your expected return at maturity on futures contracts?
b. Based on your expectation of a 10% rise in gold price, what is your expected return at maturity on option contracts?
c. Simulate the return of the two investments for various movements in the price of gold.

Question

Quizplus · Accepted Answer

The Answer is a The expected rate of return on the futures margin deposit is equal to 300%. This is found by observing that the margin per ounce of gold is $10($1,000 for contract of 100 ounces). With a 10% gold price appreciation of $40, the spot price of gold will rise to $440, which will also be the futures price on delivery date. Hence, a profit of $440 - $410 = $30, for an initial investment of $10.
b. At expiration, the option is expected to be worth $40 per ounce, since the gold price is expected to be $440 and the exercise price is $400 per ounce. This leads to a net profit of $20 and a rate of return on the initial $20 investment of 100%.
c. Gold Price Simulation

\begin{array} { l r r r r r } & \mathbf { \$ 2 0 } & \mathbf { \$ 6 0 0 } & \mathbf { \$ 4 0 0 } & \mathbf { \$ 4 4 0 } & \mathbf { \$ 4 8 0 } \\hline ext { Rate af Return: } & & & & & \ ext { Gold Bullion } & - 20 \% & - 10 \% & 0 \% & 10 \% & 20 \% \ ext { Futures } & - 900 \% & - 500 \% & - 100 \% & 300 \% & 700 \% \ ext { Option } & - 100 \% & - 100 \% & - 100 \% & 100 \% & 300 \%\end{array}

To Capitalize on Your Expectation of a 10% Gold Price