You are expected to receive 5,000,000 Swiss Franc (CHF) from the importer 90 day

Question

You are expected to receive 5,000,000 Swiss Franc (CHF) from the importer 90 days later. You want to hedge against possible devaluation of CHF in the coming 90 days. The following table shows you about derivatives (futures and options) available to you.

a. If you decide to use futures on CHF, which position (Long or Short) will you take on futures and how many contracts will you need to fully hedge?

b. Instead of using futures, you want to enjoy upside potential while protecting from downside risk. Should you buy a PUT option on CHF or a CALL option on CHF and how many PUT or CALL contracts will you need to fully hedge?

c. Using your answer, what is your net proceed in dollar (including premium) if the spot rate at the end of 90 days is $0.91/CHF?

d. Using your answer, what is your net proceed in dollar (including premium) if the spot rate at the end of 90 days is $0.97/CHF?

Futures Call Option Put Option Contract Size CHF 125,000.00 CHF 62,500.00 CHF 62,500.00 Spot Rate ($/SF) today 0.95 Future Rate ($/SF) today 0.90 Strike Price ($/SF) 0.95 0.95 Premium $ per SF $0.004 $0.005

Explanation / Answer

a)   Since today’s future rate is less than spot price, we will take long position in future.

               No. of contract=CHF 5,000,000/ CHF 125,000

                             =40 Contract

  

        b) In the given case, we have to receive 5,000,000 SF from the importer 90 days later, We should opt call option for enjoying upside potential and protecting downside risk.

No. of contracts =CHF 5,000,000/CHF 62500

                       =80 Contract

c)   In Call option, if Strike Price after 90 days is $ .91, then we will receive $ .95 because at the time of purchase, strike Price of Call Option is $ .95.

             Net proceed = no. of contracts*contract size (strike price – premium)

                                = 80 * 62500 (.95 - .004)

                                = $ 4,730,000

d) In Call option, if Strike Price after 90 days is $ .97, then we will receive $ .97 because it is the amount higher than the amount at the time of purchase of call option (i.e. .95)

Net proceed = no. of contracts*contract size (strike price – premium)

                                = 80 * 62500 (.97 - .004)

                                = $ 4,830,000

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