Analysis of Option Strategies for Hedging Copper Sales Risk

This assignment analyzes two option strategies—butterfly spread and straddle spread—for hedging foreign exchange risk associated with copper sales. The butterfly spread involves buying and selling call options with different strike prices to limit potential losses to the premium paid. The straddle spread, involving buying a call and selling a put option with the same strike price, aims to neutralize premium payments while potentially exposing the company to unlimited losses and profits. The assignment recommends both strategies based on the company's need to minimize premium costs and manage risk. References to Cohen (2013) and Saliba (2010) are included to support the analysis of these strategies.

Option Strategies for Hedging

In the given scenario, MML wants to hedge against the risk of foreign exchange which will
emanate from the sale of copper. The company is planning to produce 700000 pounds of copper
in the month of December. The management is considering Option Contract Strategies for the
purpose of hedging the foreign exchange risk. Further, it is to be noted that the management
wants to keep the payment of option premium to a reasonable amount.
In this connection two most prominently used option strategies such as butterfly spread and
straddle spread could be recommended for use by the management. The butterfly spread could be
created by the management by taking four option contracts with same date of expiry (Cohen,
2013). For this purpose, the management of MML can sell two call options and buy another two
call options. The twist is that the strike prices of these four option contracts would be different.
Firstly, the management would sell two call options at the average strike price prevailing in the
market and then it will buy one call option at the higher strike price and another one at lower
strike price (Cohen, 2013).
The butterfly spread would help the management in lowering down the risk to the lowest level.
In this case the maximum loss that the company could suffer would not be more than the cost of
original investment i.e. the sell price of 700000 pounds of copper. The butterfly spread
neutralizes the impact of sudden fall or sudden rise in the prices of underlying in the market.
Thus, this strategy could be one of the best for the management of MML to implement to save
from the loss due to foreign exchange risk (Saliba, 2010).
Apart from the butterfly, there is another convincing option strategy which is also recommended
to the management of MML. Since the management wants to neutralize the premium payments
therefore, it would be desirable for the it two buy one call option and sell one put option on

copper with the same date of expiry and same strike price (Saliba, 2010). Now, the premium paid
by the management on long call would offset by the premium received on put Option sold. The
buyer of the option has to pay premium to the seller. So, MML being buyer of call option would
pay the option premium and receive the option premium from the person to whom it sold the put
option.
However, the management of MML needs to be cautioned here. The strategy as described above
embraces the potential of unlimited loss. Though, the potential of unlimited profit is also there.
But it could be measured to be little risky in the situations. The biggest advantage of this option
strategy is the low cost of premium and the same is the priority of the management of MML.
Hence, buying one call option and selling one put option on copper with same strike price and
same date of expiration could be recommended to the management of MML (Saliba, 2010).
References
Cohen, G. 2013. Options Made Easy: Your Guide to Profitable Trading. FT Press.
Saliba, A.J. 2010. Option Strategies for Directionless Markets: Trading with Butterflies, Iron
Butterflies, and Condors. John Wiley & Sons.