Question

Heather and Kate are grain farmers in Nebraska. They farm in the same area and sell their grain in the sama cash market. They both like to use options to hedge and often buy puts when they start marketing their grain. At the end of the hedge, Heather always goes back to the options market and sells her puts (she never exercises them). On the other hand, Kate either exercises her puts (when it is worth doing so) or lets them expire at the end of the hedge.

Last March, they both bought the same puts (same strike, same premium) on the soybean futures contract for November delivery. Today they are both selling their grain in the local cash market and lifting their hedge. Since they used the same puts to hedge and they are finishing the hedge on the same day, does it mean that they will have the same realized price? Explain your answer.

Answer 1

Yes, they will have the same realized price.

This is because there are two ways to settle a put contract - cash settlement or physical delivery. In either case, the net profit will be the same (ignoring transaction and delivery costs).

Heather never exercises her puts. If the puts are not worth exercising, there is no difference between exercising or selling the put. If the puts are worth exercising, her profit from selling the put will equal the profit from exercising the option.

Kate exercises her puts. If the puts are not worth exercising, there is no difference between exercising or selling the put. If the puts are worth exercising, her profit from exercising the option will equal the profit from selling the put.