Suppose that you buy a weather call option with a strike pri

Suppose that you buy a weather call option with a strike price= 200 based on HDD because you are concerned about unexpectedly cool weather in summer. The payment rate on the option contract is $1,000 and the payment cap is $200,000.

A.) If the cumulative HDD = 320, what is your payoff?

B.) If the cumulative HDD= 450, what is your payoff?

This is all the information given.

Solution

a) payoff on the option = min(200,000, 320 - 200 * 1000)

payoff on the option = 120,000

b. payoff on the option = min (200,000, 450 - 200* 1000)

payoff on the option = min (200,000 , 250,000) = 200,000