Suppose the current spot price of wheat is $25 a bushel. A wheat farmer expects to produce 1,000 bushels at the end of the season, and she wants to ensure that she gets at least $19 a bushel. If a put option on 1,000 bushels of wheat with a strike price of $20 and an expiration date at the end of the season is selling for $1,000, the farmer can purchase the put option to guarantee she gets $19 a bushel.

Question

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By purchasing the put option with a strike price of $20, the farmer can sell her 1,000 bushels of wheat at $20 a bushel, which is higher than her desired price of $19 a bushel. The farmer will pay $1,000 for the put option, but this will ensure a minimum price of $19 a bushel, even if the spot price of wheat falls below that level.

Suppose the Current Spot Price of Wheat Is $25 a Bushel