# Question

Use the same assumptions as in the preceding problem, without the bid-ask spread.

Suppose that we want to construct a paylater strategy using a ratio spread. Instead of buying a 440-strike call, Auric will sell one 440-strike call and use the premium to buy two higher-strike calls, such that the net option premium is zero.

a. What higher strike for the purchased calls will generate a zero net option premium?

b. Graph the profit for Auric resulting from this strategy.

•XYZ mines copper, with fixed costs of $0.50/lb and variable cost of $0.40/lb.

•Wirco produces wire. It buys copper and manufactures wire. One pound of copper can be used to produce one unit of wire, which sells for the price of copper plus $5. Fixed cost per unit is $3 and noncopper variable cost is $1.50.

•Telco installs telecommunications equipment and uses copper wire fromWirco as an input. For planning purposes, Telco assigns a fixed revenue of $6.20 for each unit of wire it uses.

The 1-year forward price of copper is $1/lb. The 1-year continuously compounded interest rate is 6%. One-year option prices for copper are shown in the table below.17

In your answers, at a minimum consider copper prices in 1 year of $0.80, $0.90, $1.00, $1.10, and $1.20.

Suppose that we want to construct a paylater strategy using a ratio spread. Instead of buying a 440-strike call, Auric will sell one 440-strike call and use the premium to buy two higher-strike calls, such that the net option premium is zero.

a. What higher strike for the purchased calls will generate a zero net option premium?

b. Graph the profit for Auric resulting from this strategy.

•XYZ mines copper, with fixed costs of $0.50/lb and variable cost of $0.40/lb.

•Wirco produces wire. It buys copper and manufactures wire. One pound of copper can be used to produce one unit of wire, which sells for the price of copper plus $5. Fixed cost per unit is $3 and noncopper variable cost is $1.50.

•Telco installs telecommunications equipment and uses copper wire fromWirco as an input. For planning purposes, Telco assigns a fixed revenue of $6.20 for each unit of wire it uses.

The 1-year forward price of copper is $1/lb. The 1-year continuously compounded interest rate is 6%. One-year option prices for copper are shown in the table below.17

In your answers, at a minimum consider copper prices in 1 year of $0.80, $0.90, $1.00, $1.10, and $1.20.

## Answer to relevant Questions

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