Risk management: Consider a wheat farmer who expects to produce 50,000 bushels of wheat at the end of this season. To hedge the risk associated with wheat prices, the farmer purchases put options to cover his entire crop. The put options have a strike price of $7.50 per and a premium of $0.30 per bushel. He also sells an equal amount of call options with a strike price of $7.50 per bushel and a premium of $0.43 a bushel. Which of the following statements is NOT correct?

Question

Quizplus · Accepted Answer

If wheat prices go up substantially, the farmer will not earn more money as the call option he sold will be exercised, and he will have to sell at $7.50 per bushel regardless of the market price. The purpose of the hedge is to protect the farmer from potential losses due to a decline in wheat prices, not to speculate on an increase in wheat prices.

Risk Management: Consider a Wheat Farmer Who Expects to Produce