You are offered a chance to by a put or call option from a currency dealer with
ID: 2768895 • Letter: Y
Question
You are offered a chance to by a put or call option from a currency dealer with a strike price of USD 0.8300/CHF with June expiration and premium of USD 0.0050/CHF. Your Magic 8 Ball tells you that the spot exchange rate will reach USD .8400/CHF sometime between now and June. With USD 100,000 you found, you want to make as much speculative profits as possible using FX options.
A) Carefully derive and draw the profit functions on the two options to help you decide. Be sure to carefully label all axes, strike price, and the break-even point. Which option should you purchase? Exactly which transaction must you carry out and when in order to make the speculative profits?
B) If you used all of the USD 100,000 to speculate on the option you suggested in part A, what are your:
Total Net Profits
Notional Principal
The rate of return on this speculation assuming your Magic 8 Ball is right? (What is your loss if the Magic 8 Ball is wrong?)
Explanation / Answer
Because we expect the future spot price higher than cuurent spot price the optimum strategy is to buy a callt or sell a put option. So
1. When we buy a call
The premium paid is 0.0050
The pay off at the time of expiry will be 0.8400 -0.8300 = 0.100/chf
Total profit wil be 0.1000 - 0.0050 = 0.095
Now total usd is 100000 so it is 100000/0.095 = 1052631 Usd
When put is sold .
The premium earned is 0.005/chf.
The payoff at the time of expirtsy is nil since put expires when spotfuture is higher is current spot price.
If Magic 8 is right the rate of return is 1052631 - 100000/ 100000= 9.52%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.