You are the head of risk management for a major airline. The forward price of oil for August is $56 per barrel, the premium for an August $56 put option is $3.85, and the premium for an August $56 call option is $2.95. Construct a “cap” to hedge the airline’s August oil purchases, using a risk-free rate of 2% for 6 months (February to August). Ignore commissions, margins, and other transaction costs.
a) Show the profit table for the cap over a range of oil prices from $44 to $68 in $2 increments, and then answer these questions:
b) What synthetic option position is created by the cap?