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September 27, 2015 0 Comment

This is designed to test students on designed to test students on Topic 7 (Mechanics of option markets) and on Topic 8 (Trading strategies involving options). Students are expected to research on the consequences of a certain group’s decision on energy production. The emphasis is on analytical thinking to assess the effectiveness and implications of competitors’ hedging strategies.
Question 1 (10 marks)
You are presented with the following information on gold futures prices:
Delivery date (months) Futures price per ounce ($)
1- 880
2- 890
3- 910
6- 932
12 1008
The interest rate is 0.5 percent per month (compound basis). It costs $2 per ounce per month (payable for the whole period in advance) to store and insure gold. Each futures contract covers 100 ounces of gold. The current price of gold is $873 per ounce.
a. Identify any arbitrage opportunities by inspecting each individual contract against the spot price of gold today. Calculate the profit, if any, based on one gold futures
contract. (8 marks)
b. Describe any arbitrage opportunities by combining any two futures contracts. No calculations are required here. (2 marks)

Question 2 (20 marks)
On 27 November 2014, Organization of Petroleum Exporting Countries (OPEC) members met in Vienna to reject calls for drastic action to cut their oil output from 30 million barrels per day and rolled over this production figure. OPEC has continually iterated that the organization has no intention to meet again until June 2015. Market observers believe a cut in production at this meeting is even less likely than at last November’s talks. Crude oil prices, as benchmarked by West Texas Intermediate (WTI) crude, have been falling since mid- June 2014 from the high of $107 per barrel to a 6-year low of $42.02 per barrel on 18 March 2015.
a. Discuss the main reason for OPEC’s decision (up to June 2015) not to cut oil production. (5marks)
b. Using the WTI benchmark, discuss the effectiveness and implications of derivatives hedging strategies of shale oil producers.. Your answer should use the WTI spot price chart (from June 2014) to justify the types of options and futures strategies employed by these producers. (15marks)
Note: Word count requirement is between 1,000 to 1,500 words. There must be a minimum of 10 references.

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