An August CDD weather option is offered on the cumulative monthly CDD at an Atlanta weather station. An investor has a long call with a strike price of 375 and a short call with a strike price of 400. The payment is $10,000 per degree day. What is the maximum payoff?

Question

Quizplus · Accepted Answer

To determine the maximum payoff, we need to find the maximum number of potential degree days that could occur during August. The difference between the strike prices of the two options is $25 (400 - 375). Therefore, for each degree day above the strike price of 400, the investor would receive $10,000, up to a maximum of $25 x 10,000 = $250,000 for 25 degree days. Any additional degree days above 425 would not result in additional payment since the short call with a strike price of 400 would effectively cap the payoff. Therefore, the maximum payoff is $250,000.

An August CDD Weather Option Is Offered on the Cumulative