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ADMS 1000 Lecture Notes - Lecture 6: Spot Contract, Call Option

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blushweasel304
6 Jul 2018
School
York University
Department
Administrative Studies
Course
ADMS 1000
Professor
Alan Shapiro

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ADMS 1000 Full Course Notes
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ADMS 1000 Full Course Notes
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Document Summary

The purchaser of a call option will break even if the revenue from selling the currency equals the payments made for the currency (at the strike price) plus the option premium. Some financial institutions may have a division that uses currency options (and other currency derivatives) to speculate on future exchange rate movements. It would be irresponsible if the firm instead used those funds to speculate in currency derivatives. An mnc"s board of directors attempts to ensure that the mnc"s operations are consistent with its goals. A call option will break even if the revenue from selling the currency equals the payments made for the currency (at the strike price) plus the option premium. In other words, regardless of how many units a contract is for, a purchaser will break even if the spot rate at which the currency is sold is equal to the strike price plus the option premium.

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Related Questions

A put option on yen is written with a strike price of ¥105.00/$. How much profit/loss will you make if you choose to exercise the option at ¥107.00/$?

A call option on euros is written with a strike price of $1.30/euro. How much profit/loss will you make if you choose to exercise the option at $1.45/euro?

A call option on UK pounds has a strike price of $2.05/£ and a cost of $0.02. What is the break-even price for the option?

Your U.S firm has an accounts payable denominated in UK pounds due in 6 months. What you should do by using currency options to protect yourself against unexpected changes in the dollar/pound exchange rate?

What will be your maximum gain and maximum loss in dollars, if you short a euro call option against dollar with strike price of $1.35/euro and at a premium of $0.07?

What will be your maximum gain and maximum loss, if you long a UK pounds put option with strike price of $1.80/£ and a cost of $0.7?

What will be your maximum gain and maximum loss, if you short a Japanese Yen put option with strike price of ¥103.00/$ and a cost of ¥10?

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?)

Looking at the following options table:

British Pound Option Prices (U.S. CENTS per Pound, 62,500 pounds per contract)
US cents/£ Call Call Call Put Put Put
Spot Rate Strike Price May June July May June July
144.8 144 0.88 1.42 1.44 0.52 1.06 -----
144.8 145 0.42 1.02 ----- ----- ----- -----
144.8

146

 0.2 0.68 0.72 1.75 2.32 -----
QUESTION A: Give me one example of an option that is out of the money? Be specific as far as month and strike price. Explain your answer?
QUESTION B: Give me one example of an option that is in the money? Be specific as far as month and strike price. Explain your answer?
QUESTION C: Which, if any, option is at the money? Explain your answer.
QUESTION D: Looking at the July 144 CALL option, break down the option's premium into its Intrinsic Value and Time Premium components
Show your calculations.
QUESTION E: Looking at the June 146 PUT option, break down the options premium into its Intrinsic Value and Time Premium components
Show your calculations.
QUESTION F : If you purchase two (2) June 145.0 call options what will be the total amount of your premium that you need to pay?
QUESTION G: Referring to QUESTION F, when do you pay the option premium, on the settlement date or on the date that you purchase the options?
QUESTION H: Today you purchase three (3) June 144.0 Puts. On settlement date the spot rate = 142.5 cents per pound, what is your net profit/loss?
Show your calculations.
QUESTION H: Today you purchase two (2) June 144.0 Calls. On settlement date the spot rate = 143.5 cents per pound, what is your net profit/loss?