Mega Company believes the price of oil will increase in the coming months. Therefore, it...
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Accounting
Mega Company believes the price of oil will increase in the coming months. Therefore, it decides to purchase call options on oil as a price-risk-hedging device to hedge the expected increase in prices on an anticipated purchase of oil. On November 30, 20X1, Mega purchases call options for 11,000 barrels of oil at $32 per barrel at a premium of $2 per barrel with a March 1, 20X2, call date. The following is the pricing information for the term of the call:
Date
Spot Price
Futures Price (for March 1, 20X2, delivery)
November 30, 20X1
$
32
$
33
December 31, 20X1
33
34
March 1, 20X2
35
The information for the change in the fair value of the options follows:
Date
Time Value
Intrinsic Value
Total Value
November 30, 20X1
$
22,000
$
0
$
22,000
December 31, 20X1
6,000
11,000
17,000
March 1, 20X2
33,000
33,000
On March 1, 20X2, Mega sells the options at their value on that date and acquires 11,000 barrels of oil at the spot price. On June 1, 20X2, Mega sells the oil for $36 per barrel. Required: a. Prepare the journal entry required on November 30, 20X1, to record the purchase of the call options.
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