Presentation on theme: "Da Players’ Gold Store Where we sell gold cheap….real cheap!!!! Colin Dunn Mike Gaffney Mike Oberdorf."— Presentation transcript:
Da Players’ Gold Store Where we sell gold cheap….real cheap!!!! Colin Dunn Mike Gaffney Mike Oberdorf
Business Problem Our business has agreed to take shipment of 35,400 ounces of gold on April 1, 2000 At present, the price for this gold is approximately $10 million dollars Our worry is that the gold price will drop and thus decrease the value of our shipment
Market View: Gold Prices For the past ten years, gold funds have averaged an annual loss of 5% The overall trend is that the price of gold is falling although there have been sudden unexpected spikes in the price We foresee that the price of gold will be significantly more volatile than the market with a possibility for a large decline Therefore, the value of the gold we will receive will decline relative to forward
Business Risk Position: Long Gold (+F) On April 1, 2000, we will receive 35,400 ounces Being risk averse, we will hedge our position
Risk Premium Estimate We will use a risk premium estimate of 2% Risk premium estimates for gold have been seen as high as 5.5%, but this estimate is based on the years 1961-91 which included periods of high inflation It does not take into account the 1990s where gold did not perform well We believe that the most recent performance of gold prices is more indicative of future prices and therefore are using the 2% risk premium
Maturity Date Differences Futures Maturity Date: April 1, 2000 Options Maturity Date: March 10, 2000 The options on the futures contracts matures before the actual futures contracts settle Therefore, we must make our decision about hedging our position on March 10 when the options mature
Value at Risk (cont’d) We are looking to structure our position so that we only have a 5% chance of losing more than 10% (or $1,000,000) To structure this position using only futures contracts, we will short 178 contracts which will leave our net position at 176 contracts long
Options Positions We have also identified several options positions that can be used to hedge our position The next several slides evaluate the different strategies and how to make sure that we don’t get our face RIPPED OFF!!!
Evaluation of Bear Spread Position: +F +Pitm –Citm View: Limited down, (concern big up) Pro: –Makes money atm –Insures against Volatility Con: –Fails to capitalize on big down Decision: –Low maximum loss but not completely in line with downward view.
Evaluation of Long Strangle Position: +F +Potm +Pitm View: Volatile (Neutral but slight bias downward) Pro: –Unlimited Gain –Limited Loss –Less expensive than +F +Potm +Pitm Con: –Expensive Decision: –Largest loss within range of volatility
Evaluation of Long Straddle Position: +F +Pitm +Pitm View: Volatile, (Neutral, bias downward) Pros: –Unlimited Gain –Limited Loss –Less Expensive than +F +2Pitm Con: –Costly Decision: –Lowest possible loss within range, biased towards market expectation
Evaluation of Synthetic Long Put itm Position: +F +Pitm +Pitm +Pitm –Citm View: Down, (Less unsure than atm) Pro: –Limited downside –Unlimited Upside Con: –Given recent volatility considerable potential for loss Decision: –Maximizes our return based on our view but potential for loss given vol.
Recommendation The Long Straddle capitalizes on our view that the price of Gold will be volatile with a bias downward. The second of the two synthetic long puts is also attractive because it fits within our acceptable loss range while maximizing our upward potential given our bias downward. However it is slightly risky because any upward movement results in a significant loss.