Hershey's Chocolate is concerned about cocoa prices prior to building inventory for Halloween sales. Analysts project that the price per ton could vary from $2,900 to $3,100. A September call option can be purchased with a $2,950 strike price for a premium of $145. What is Hershey's worst-case scenario if it purchases these options?
A) Cocoa prices will rise to $3,100 and Hershey is protected only to a price of $2,950.
B) Cocoa prices will decline to $2,850 and Hershey will have to pay an extra $100 per ton.
C) Cocoa prices will not rise above Hershey's break-even price of $3,095, which equals the sum of the strike price plus the option premium.
D)Cocoa prices will fall below $2,950 and Hershey will lose $145 per option contract.

Question

Quizplus · Accepted Answer

Hershey's worst-case scenario after purchasing the call options is that cocoa prices fall below the strike price of $2,950. In this case, Hershey would not exercise the option and would lose the premium paid for the option, which is $145 per option contract. This loss occurs because the option becomes worthless if the market price is below the strike price, as Hershey could purchase cocoa at a lower price in the market without exercising the option.

Hershey's Chocolate Is Concerned About Cocoa Prices Prior to Building