366 PA R T I V The Management of Financial Institutions Profit ($) 12 000 Profit ($) 12 000 Buyer of Futures Buyer of Call Option 10 000 8000 10 000 8000 D 6000 6000 4000 4000 C 2000 2000 110 115 120 125 A B Price of Futures Contract at Expiration ($) 2000 A 110 115 120 125 Buyer of 2000 B 4000 4000 6000 6000 8000 8000 10 000 10 000 12 000 Loss ($) 12 000 Loss ($) (a) Profit or loss for buyer of call option and buyer of futures F I G U R E 14 - Price of Futures Contract at Expiration ($) C D Put Option Seller of Futures (b) Profit or loss for buyer of put option and seller of futures Profits and Losses on Options Versus Futures Contracts The futures contract is the $100 000 June Canada bond contract, and the option contracts are written on this futures contract with an exercise price of 115 Panel (a) shows the profits and losses for the buyer of the call option and the buyer of the futures contract, and panel (b) shows the profits and losses for the buyer of the put option and the seller of the futures contract exercising the option minus the $2000 premium), plotted as point D Plotting these points, we get the kinked profit curve for the call option that we see in panel (a) Suppose that instead of purchasing the futures option contract in February, Irving decides to buy the $100 000 June Canada bond futures contract at the price of 115 If the price of the bond on the expiration day at the end of June declines to 110, meaning that the price of the futures contract also falls to 110, Irving suffers a loss of percentage points, or $5000 The loss of $5000 on the futures contract at a price of 110 is plotted as point A* in panel (a) At a price of 115 on the expiration date, Irving would have a zero profit on the futures contract, plotted as point B* At a price of 120, Irving would have a profit on the contract of percentage points, or $5000 (point C*), and at a price of 125, the profit would be 10 percentage points, or $10 000 (point D*) Plotting these points, we get the linear (straight-line) profit curve for the futures contract that appears in panel (a)