Evaluating the impact of hedging a forecasted transaction with an option. Casper Enterprises is forecasting two significant transactions and is concerned that adverse price movements could negatively impact these transactions. In order to hedge against adverse movements, Casper has acquired two options as described below.
The first forecasted transaction involves the purchase of a commodity with the concern being that commodity prices could increase prior to the transaction actually taking place. As a defensive move, Casper acquired Option A. The option is a call option involving 200 tons of a commodity with a strike price of $1,500 per ton with delivery of the commodity in 90 days.
The other forecasted transaction involves the sale of 100,000 bushels of a harvested commodity with the concern that the price of the commodity may decrease prior to the transaction actually taking place. As a defensive move, Casper acquired Option B. The option is a put option involving 100,000 bushels of the commodity with a strike price of $2.50 per bushel and delivery in 90 days.
Effectiveness of the hedge is measured by comparing the changes in the intrinsic value of the option with changes in the forecasted cash flows based on spot rates. The time value is to be expensed over the life of the option. Information concerning the options is as follows:
For each option, determine the following balances at both 30 days and 60 days after inception of the option: Investment in Option, Other Comprehensive Income, and Gain or Loss on Option (the change in time value).