One year ago, you bought a put option on 200,000 euros with an expiration date o

Question

One year ago, you bought a put option on 200,000 euros with an expiration date of one year. You paid a premium on the put option of $.04 per unit. The exercise price was $1.31. Assume that one year ago, the spot rate of the euro was $1.29, the one-year forward rate exhibited a discount of 2%, and the one-year futures price was the same as the one-year forward rate. From one year ago to today, the euro depreciated against the dollar by 3 percent. Today the put option will be exercised (if it is feasible for the buyer to do so).

b. Now assume that instead of taking a position in the put option one year ago, you sold a futures contract on 200,000 euros with a settlement date of one year. Determine the total dollar amount of your profit or loss.

Explanation / Answer

(i)Spot rate of euro= $1.29

Premium price for each put option of exercise price $1.31 is $0.04, which means that if the prices of euro falls below $1.27 (1.31-0.04), the position would be profitable in nature

200,000 euro put options were purchased which implies that the cost of purchase= 200,000*0.04= $8000

Now, as the euro depreciated by 3% in 1 year span, the euro price at expiry is = 1.29*0.97= $1.2513

As the price has fallen below $1.27, the put option should be exercised. At the day of expiry, the individual should but in spot and sell using put option.

Profit on each euro would be=$1.27-$1.2513

Thus profit for 200000 euros would be=200000*(1.27-1.2513)= $3740

(ii)Futures were sold on 200000 euros

1 year future price was trading at 2% discount= 1.29*0.98= $ 1.2642

The current price is $1.2513

Thus, profit made on each euro is=1.2642-1.2513= $ 0.0129

And, thus the profit made on 200000 euros is =200000*0.0129= $2580

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