FINC3240FINC3240International FinanceInternational Finance

Chapter 5Chapter 5

Currency OptionsCurrency Options

11

22

What is an option?What is an option?

A derivative security that gives the holder (buyer) A derivative security that gives the holder (buyer)

the the rightright to buy or sell to buy or sell an underlying assetan underlying asset at a at a

specified pricespecified price (“exercise price”) (“exercise price”) on or beforeon or before the the

option option expiration dateexpiration date. .

33

Two types of options:Two types of options:Call vs. Put optionsCall vs. Put options

Call optionCall option Gives holder the Gives holder the right to buy right to buy an asset at a an asset at a

specified exercise price on or before a specified exercise price on or before a specified expiration date. specified expiration date.

Put optionPut option Gives holder the Gives holder the right to sellright to sell an asset at a an asset at a

specified exercise price on or before a specified exercise price on or before a specified expiration date. specified expiration date.

44

Exercise priceExercise price

Exercise priceExercise price• For a call option, it is the price set for For a call option, it is the price set for

buying the underlying asset. buying the underlying asset. • For a put option it is the price set for For a put option it is the price set for

selling the underlying asset. selling the underlying asset.

Exercise price is also called the strike Exercise price is also called the strike price.price.

55

Option premiumOption premium

Options are financial assets. If you want an Options are financial assets. If you want an option, you have to buy it from an option seller option, you have to buy it from an option seller (counterparty). (counterparty).

The purchase price or cost of an option is the The purchase price or cost of an option is the option premiumoption premium. .

The option seller earns the option premium.The option seller earns the option premium. The option premium is an immediate expense for The option premium is an immediate expense for

the buyer and an immediate return for the seller, the buyer and an immediate return for the seller, whether or not the holder (buyer) ever exercises whether or not the holder (buyer) ever exercises the option. the option.

ExamplesExamples

At March 1, XYZ stock’s spot price = $95. A trader At March 1, XYZ stock’s spot price = $95. A trader buys a call option on XYZ at strike (exercise) price buys a call option on XYZ at strike (exercise) price = $100/share. The right lasts until August 15, and = $100/share. The right lasts until August 15, and the price (option premium) of this call option is the price (option premium) of this call option is $2.5/share. $2.5/share.

At March 1, ABC stock’s spot price = $100. A At March 1, ABC stock’s spot price = $100. A trader buys a put option to on ABC at strike trader buys a put option to on ABC at strike (exercise) price = $105/share. The right lasts (exercise) price = $105/share. The right lasts until August 15, and the price (option premium) until August 15, and the price (option premium) of this of this put option is $8.2/share.put option is $8.2/share.

66

77

The long and short The long and short

If you If you buybuy an option, then you are an option, then you are

• ““long the option” long the option” or “or “long option” or long option” or you have a you have a

“long position”“long position”. .

If you If you sellsell an option, then you are an option, then you are

• ““short the option” short the option” or or “short option” or “short option” or you have you have

aa “short position”. “short position”.

Example: if you buy a call option, you are “long call”. Example: if you buy a call option, you are “long call”.

Options FeaturesOptions Features

There are always two positions in each There are always two positions in each option contract: option contract:

Long for the buyer vs. Short for the sellerLong for the buyer vs. Short for the seller

(1)(1)Buying a Call → Long a CallBuying a Call → Long a Call

(2)(2)Selling a Call → Short a CallSelling a Call → Short a Call

(3) Buying a Put → Long a Put(3) Buying a Put → Long a Put

(4) Selling a Put → Short a Put(4) Selling a Put → Short a Put

88

PositionsPositions

Buyer (Long) Seller (Short)

Call- Right to buy the underlying

(i.e. to exercise the option)- Pays the premium

- Obligation to sell the underlying, if buyer exercises the option

- Receives the premium

Put- Right to sell the underlying

(i.e. to exercise the option)- Pays the premium

- Obligation to buy the underlying, if buyer exercises the option

- Receives the premium

99

1010

Options trading (1)Options trading (1)

Option contracts are traded in two Option contracts are traded in two types of markets:types of markets:

1.1. Over-the-counter (OTC) marketsOver-the-counter (OTC) markets

2.2. Exchanges, such as:Exchanges, such as:• Chicago Board Options Exchange Chicago Board Options Exchange

(CBOE)(CBOE)• Chicago Mercantile Exchange (CME)Chicago Mercantile Exchange (CME)• International Securities ExchangeInternational Securities Exchange Option Clearing Corporation (OCC)Option Clearing Corporation (OCC)

1111

Options trading (2)Options trading (2)

OTCOTC

1.1. Option contract Option contract can be can be customized to customized to needs of trader. needs of trader.

2.2. Difficult to trade. Difficult to trade. Secondary market Secondary market illiquid.illiquid.

ExchangesExchanges

1.1. Option contracts Option contracts are standardized are standardized by maturity dates by maturity dates and exercise and exercise price. price.

2.2. Easy to trade. Easy to trade. Secondary market Secondary market is liquid. is liquid.

1212

Options on IBM June 7, 2004Options on IBM June 7, 2004Source: Wall Street Journal Online Edition, June 8, 2004.Source: Wall Street Journal Online Edition, June 8, 2004.

1313

Underlying assetUnderlying asset

Individual stocksIndividual stocks Stock market indexesStock market indexes

• S&P 100, S&P 500, DJIA, Nikkei 225, S&P 100, S&P 500, DJIA, Nikkei 225, FTSE 100 etc.FTSE 100 etc.

FuturesFutures Foreign currencyForeign currency Treasury bonds, Treasury notesTreasury bonds, Treasury notes

And many others.And many others.

1414

Option exercise (1)Option exercise (1)

To To “exercise a call option”“exercise a call option” means the buyer means the buyer uses the option to uses the option to buybuy the underlying the underlying assetasset at the exercise price. at the exercise price.

To To “exercise a put option”“exercise a put option” means the buyer means the buyer uses the option to uses the option to sellsell the underlying asset the underlying asset at the exercise price. at the exercise price.

1515

Option exercise (2)Option exercise (2)

Question: When do you exercise an option?Question: When do you exercise an option?Answer: Simple. Only when it’s optimal to do so. Answer: Simple. Only when it’s optimal to do so.

That is, when you are better off exercising the That is, when you are better off exercising the option. option.

Question: What if exercising the option does Question: What if exercising the option does not make me better off?not make me better off?

Answer: Simple. Don’t exercise. After all, it’s just an Answer: Simple. Don’t exercise. After all, it’s just an option. option.

1616

American vs. European optionsAmerican vs. European options

American option: Holder has the right to American option: Holder has the right to exercise the option exercise the option on or beforeon or before the the expiration dateexpiration date. .

European option: Holder has the right to European option: Holder has the right to exercise the option exercise the option only on only on the expiration the expiration datedate. .

1717

Payoffs of a Call OptionPayoffs of a Call Option

Long Call at $20Long Call at $20 Short Call at $20Short Call at $20

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

1818

Profit/Loss of a Call OptionProfit/Loss of a Call Option

Long Call at $20Long Call at $20 Short Call at $20Short Call at $20

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

1919

Profit/Loss of Long and Short on Profit/Loss of Long and Short on Call OptionCall Option

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

2020

Payoffs of a Put OptionPayoffs of a Put Option

Long Put at $20Long Put at $20 Short Put at $20Short Put at $20

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

2121

Profit/Loss of a Put OptionProfit/Loss of a Put Option

Long Put at $20Long Put at $20 Short Put at $20Short Put at $20

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

2222

Profit/Loss of Long and Short on Profit/Loss of Long and Short on Put OptionPut Option

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

2323

Call Option’s Payoff/Profit at ExpirationCall Option’s Payoff/Profit at Expiration

Payoff for a Long Call: Payoff for a Long Call:

Profit for a Long Call: payoff Profit for a Long Call: payoff – – option premiumoption premium

Payoff for a Short Call: Payoff for a Short Call:

Profit for a Short Call: option premium Profit for a Short Call: option premium + + payoffpayoff

XSif

XSifXS

T

TT

0

XSif

XSifXS

T

TT

0

)(

2424

Put Option’s Payoff/Profit at ExpirationPut Option’s Payoff/Profit at Expiration

Payoff for a Long Put: Payoff for a Long Put:

Profit for a Long Put: payoff Profit for a Long Put: payoff –– option premium option premium

Payoff for a Short Put: Payoff for a Short Put:

Profit for a Short Put: option premium Profit for a Short Put: option premium ++ payoff payoff

XSif

XSifSX

T

TT

0

XSif

XSifSX

T

TT

0

)(

2525

ExampleExample A trader short a Call at X=20 with a premium of A trader short a Call at X=20 with a premium of

$5. At maturity, the stock price is 30. What is the $5. At maturity, the stock price is 30. What is the profit/loss to this trader?profit/loss to this trader?

Profit/Loss = 5 + [-(30-20)] = 5 -10 = -5Profit/Loss = 5 + [-(30-20)] = 5 -10 = -5

A trader long a Put at X=30 with a premium of A trader long a Put at X=30 with a premium of $5. At maturity, the stock price is 15. What is the $5. At maturity, the stock price is 15. What is the profit/loss to this trader?profit/loss to this trader?

Profit/Loss = (30-15) - 5 = 15 - 5 = 10Profit/Loss = (30-15) - 5 = 15 - 5 = 10

2626

Call option: Call option: Payoff & Profit at expiration Payoff & Profit at expiration

Consider a Consider a call optioncall option on a share of IBM stock with on a share of IBM stock with an exercise price of $80 per share. Suppose this an exercise price of $80 per share. Suppose this call option expires on July 16, 2004 and today is call option expires on July 16, 2004 and today is the expiration date. The current call option the expiration date. The current call option premium is $5.premium is $5.

1.1. Are you better off exercising the option?Are you better off exercising the option?

2.2. What is the payoff from the option exercise?What is the payoff from the option exercise?

3.3. What is the profit from the option exercise?What is the profit from the option exercise?

4.4. What is the breakeven point for this call option (that is, the What is the breakeven point for this call option (that is, the stock price at which profit is zero)?stock price at which profit is zero)?

Answer these questions if IBM’s stock price is (a) 95 (b) 76 (c) 81.Answer these questions if IBM’s stock price is (a) 95 (b) 76 (c) 81.

2727

Payoff & profit diagram of call Payoff & profit diagram of call option holder at expirationoption holder at expiration

-6

-4

-2

0

2

4

6

8

10

12

14

Stock price at expiration

Pay

off/

prof

it

call payoff 0 0 0 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

call profit -5 -5 -5 -5 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10

76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95

cost of option

Payoff

Profit

Break even point

2828

Payoff & profit diagram of call Payoff & profit diagram of call option writer at expirationoption writer at expiration

-20

-15

-10

-5

0

5

10

Stock price at expiration

Payo

ff/ p

rofit

call w riter payoff 0 0 0 0 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 -10 -11 -12 -13 -14 -15

call w riter profit 5 5 5 5 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 -10

76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95

Break even point

option premium

Payoff

Profit

2929

Call ReviewCall Review Which of the following statements about the value (i.e., Which of the following statements about the value (i.e.,

payoff) of a call option at expiration is payoff) of a call option at expiration is falsefalse??

a.a. A short position in a call option will result in a loss if the A short position in a call option will result in a loss if the stock price exceeds the exercise price.stock price exceeds the exercise price.

b.b. The value of a long position equals zero or the stock price The value of a long position equals zero or the stock price minus the exercise price, whichever is higher.minus the exercise price, whichever is higher.

c.c. The value of a long position equals zero or the exercise The value of a long position equals zero or the exercise price minus the stock price, whichever is higher.price minus the stock price, whichever is higher.

d.d. A short position in a call option has a zero value for all stock A short position in a call option has a zero value for all stock prices equal to or less than the exercise price. prices equal to or less than the exercise price.

3030

Put option: Put option: Payoff & Profit at expiration (1)Payoff & Profit at expiration (1)

Consider a Consider a put optionput option on a share of IBM stock on a share of IBM stock with an exercise price of $80 per share. Suppose with an exercise price of $80 per share. Suppose this put option expires on July 16, 2004 and today this put option expires on July 16, 2004 and today is the expiration date. The current put option is the expiration date. The current put option premium is $3.premium is $3.

1.1. Are you better off exercising the option?Are you better off exercising the option?

2.2. What is the payoff from the option exercise?What is the payoff from the option exercise?

3.3. What is the profit from the option exercise?What is the profit from the option exercise?

4.4. What is the breakeven point for this put option?What is the breakeven point for this put option?

Answer these questions if IBM’s stock price is (a) 73, (b) 78 Answer these questions if IBM’s stock price is (a) 73, (b) 78 and (c) 81.and (c) 81.

3131

Payoff & profit diagram of put Payoff & profit diagram of put option holder at expirationoption holder at expiration

-4

-2

0

2

4

6

8

10

Stock price at expiration

Payo

ff/ p

rofit

put payoff 10 9 8 7 6 5 4 3 2 1 0 0 0 0 0 0 0 0 0 0

put profit 7 6 5 4 3 2 1 0 -1 -2 -3 -3 -3 -3 -3 -3 -3 -3 -3 -3

70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89

option premium

Break even point

Profit

Payoff

3232

Payoff & profit diagram of put Payoff & profit diagram of put option writer at expirationoption writer at expiration

-10

-8

-6

-4

-2

0

2

4

Stock price at expiration

Payo

ff/ p

rofit

put w riter payoff -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 0 0 0 0 0 0 0 0 0

put w riter profit -7 -6 -5 -4 -3 -2 -1 0 1 2 3 3 3 3 3 3 3 3 3 3

70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89

option premium

Payoff

Profit

Break even point

3333

Put ReviewPut Review Consider a put option written on ABC Inc.’s stock. Consider a put option written on ABC Inc.’s stock.

The put option’s exercise price is $80. Which of The put option’s exercise price is $80. Which of the following statements about the value (payoff) the following statements about the value (payoff) of the put option at expiration is of the put option at expiration is truetrue??

a.a. The value of the short position in the put is $4 if The value of the short position in the put is $4 if the stock price is $76.the stock price is $76.

b.b. The value of the long position in the put is -$4 if The value of the long position in the put is -$4 if the stock price is $76.the stock price is $76.

c.c. The long put has value when the stock price is The long put has value when the stock price is below the $80 exercise price.below the $80 exercise price.

d.d. The value of the short position in the put is zero The value of the short position in the put is zero for stock prices equaling or exceeding $76. for stock prices equaling or exceeding $76.

Practice QuestionsPractice Questions

To be assigned on the course websiteTo be assigned on the course website

3434

3535

Moneyness (1)Moneyness (1)

An option (call or put) is: An option (call or put) is:

1.1.In the money (ITM) if exercising it produces a In the money (ITM) if exercising it produces a

positive payoff to the holderpositive payoff to the holder

2.2.At the money (ATM) if the asset price and exercise At the money (ATM) if the asset price and exercise

price are equal.price are equal.

3.3.Out of the money (OTM) if exercising it produces a Out of the money (OTM) if exercising it produces a

negative payoff to the holder. negative payoff to the holder.

3636

Moneyness (2)Moneyness (2)

ST < X ST = X ST > X

Call options Out of the money

At the money In the money

Put options In the money

At the money Out of the money

3737

Moneyness questions (1)Moneyness questions (1) Consider two call options written on ABC Consider two call options written on ABC

Inc.’s stock. The first call, C1, has an exercise Inc.’s stock. The first call, C1, has an exercise price of $50. The second call, C2, has an price of $50. The second call, C2, has an exercise price of $70. Both calls have the exercise price of $70. Both calls have the same expiration date. Today is the expiration same expiration date. Today is the expiration date. C1 is date. C1 is in the moneyin the money while C2 is while C2 is out of the out of the moneymoney. Which of the following is true about . Which of the following is true about SSTT, the stock price on the expiration date?, the stock price on the expiration date?

a.a. SSTT > $50 > $50b.b. SSTT > $70 > $70c.c. $70 > S$70 > STT > $50 > $50d.d. SSTT < $50 < $50

3838

Moneyness questions (2)Moneyness questions (2) Consider two put options written on XYZ Consider two put options written on XYZ

Inc.’s stock. The first put, P1, has an exercise Inc.’s stock. The first put, P1, has an exercise price of $20. The second put, P2, has an price of $20. The second put, P2, has an exercise price of $35. Both puts have the exercise price of $35. Both puts have the same expiration date. Today is the expiration same expiration date. Today is the expiration date. P1 is date. P1 is out of the moneyout of the money while P2 is while P2 is in the in the moneymoney. Which of the following is true about . Which of the following is true about SSTT, the stock price on the expiration date?, the stock price on the expiration date?

a.a. SSTT < $20 < $20b.b. SSTT < $35 < $35c.c. $20 < S$20 < STT < $35 < $35d.d. SSTT > $35 > $35

How to close a position?How to close a position?

1. reverse trading before expiration1. reverse trading before expiration

2. execute the option2. execute the option

3. wait for expiration 3. wait for expiration

3939

4040

Protective Put StrategyProtective Put Strategy

Portfolio consisting of a put option Portfolio consisting of a put option and the underlying asset.and the underlying asset.

Guarantees that minimum portfolio Guarantees that minimum portfolio value (payoff) is equal to the put’s value (payoff) is equal to the put’s exercise price. exercise price.

4141

Protective put: Protective put: Payoff & profit at expirationPayoff & profit at expiration

SS00 = initial asset price, and = initial asset price, and P = put option premium.P = put option premium.Cost of the position = asset price + put premiumCost of the position = asset price + put premium

= S= S00 + P + P

ST ≤ X ST > X

Payoff of stock ST ST

Payoff of put X – ST 0

Total payoff X ST

Profit X – (S0+P) ST – (S0 + P)

4242

Payoff & profit of protective Payoff & profit of protective put position at expirationput position at expiration

43

Currency OptionsCurrency Options

A contract that is associated with a right to buy or A contract that is associated with a right to buy or sell a currency until after a specific date with a sell a currency until after a specific date with a predetermined price (strike price) and amount. predetermined price (strike price) and amount. There are Call options and Put options.There are Call options and Put options.

1.1. The buyer of a Call option has the right, not the The buyer of a Call option has the right, not the obligation, to obligation, to buybuy a currency. a currency.

2.2. The buyer of a Put option has the right, not the The buyer of a Put option has the right, not the obligation, to obligation, to sellsell a currency. a currency.

http://www.cmegroup.com/trading/fx/g10/euro-fx_contractSpecs_options.html#prodType=AMEhttp://www.cmegroup.com/trading/fx/g10/euro-fx_contractSpecs_options.html#prodType=AME

4343

Contingency (payoff) Graphs for Contingency (payoff) Graphs for Currency OptionsCurrency Options

1. Contingency Graph for a Buyer of a 1. Contingency Graph for a Buyer of a Call OptionCall Option

2. Contingency Graph for a Seller of a 2. Contingency Graph for a Seller of a Call OptionCall Option

3. Contingency Graph for a Buyer of a 3. Contingency Graph for a Buyer of a Put OptionPut Option

4. Contingency Graph for a Seller of a 4. Contingency Graph for a Seller of a Put Option Put Option

4444

Insert exhibit 5.6 page 123Insert exhibit 5.6 page 123

Contingency Graphs for Currency Options

4545

Currency Call Options Premium Currency Call Options Premium

Factors Affecting Currency Call Factors Affecting Currency Call Option PremiumsOption Premiums

a. Level of existing spot price relative to strike price

b. Length of time before the expiration date

c. Potential variability of currency

4646

Currency Put Options PremiumCurrency Put Options Premium

Factors Affecting Currency Put Factors Affecting Currency Put Option PremiumsOption Premiumsa. Level of existing spot price relative to strike price

b. Length of time before the expiration date

c. Potential variability of currency

4747

Call Options ApplicationCall Options Application

Hedge payables (Example on page 135)Hedge payables (Example on page 135)

Pike Co. orders Australian goods and makes a Pike Co. orders Australian goods and makes a payment in Australian dollars (A$) upon delivery. payment in Australian dollars (A$) upon delivery. This company can buy an A$ call option that locks This company can buy an A$ call option that locks in a maximum rate. If at the maturity date the in a maximum rate. If at the maturity date the A$’s value remains below the strike price, Pike A$’s value remains below the strike price, Pike can purchase A$ at the prevailing spot rate and can purchase A$ at the prevailing spot rate and simply let its call option expire. If the A$’s value simply let its call option expire. If the A$’s value rises above the strike price, Pike will execute the rises above the strike price, Pike will execute the option and buy A$ at the strike price.option and buy A$ at the strike price.

4848

Call Options ApplicationCall Options Application

A payment in A$1,000,000 will be delivered (paid A payment in A$1,000,000 will be delivered (paid out) at the end of June.out) at the end of June.

On March 1, an option on A$100,000 that expires On March 1, an option on A$100,000 that expires on June 28 has a strike price of $0.9090.on June 28 has a strike price of $0.9090.

Pike Co. buys 10 A$ Call options on March 1 and Pike Co. buys 10 A$ Call options on March 1 and pay premium of $0.0150.pay premium of $0.0150.

On June 28, On June 28, If the spot rate is If the spot rate is $0.9050$0.9050, Pike purchases A$ at the , Pike purchases A$ at the

prevailing spot rate, and simply let its call options expire. prevailing spot rate, and simply let its call options expire. If the spot rate is A$1.050, Pike executes the options and If the spot rate is A$1.050, Pike executes the options and

buy A$ at the strike price, buy A$ at the strike price, $0.9090.$0.9090.4949

Put Options ApplicationPut Options Application Hedge receivables Hedge receivables

ABC Co. will receive payment in C$2,000,000 at the end of ABC Co. will receive payment in C$2,000,000 at the end of September.September.

On March 1, an option on C$10,000 that expires on September On March 1, an option on C$10,000 that expires on September 28 has a strike price of $0.9500.28 has a strike price of $0.9500.

ABC Co. buy 200 C$ Put options on March 1 and pay $0.0100 ABC Co. buy 200 C$ Put options on March 1 and pay $0.0100 premium.premium.

On September 28, On September 28, If the spot rate is $0.9400, ABC executes the options and sell If the spot rate is $0.9400, ABC executes the options and sell

C$ at the strike price, C$ at the strike price, $0.9500.$0.9500. If the spot rate is $0.9600/$, ABC sells C$ at the prevailing spot If the spot rate is $0.9600/$, ABC sells C$ at the prevailing spot

rate, rate, $0.9600$0.9600, and simply let its put options expire. , and simply let its put options expire.

http://www.nasdaq.com/includes/canadian-dollar-specifications.stmhttp://www.nasdaq.com/includes/canadian-dollar-specifications.stm

5050

Speculation with Call Options (1)Speculation with Call Options (1)example on page 137, Mr. Jimexample on page 137, Mr. Jim

Strike price=$1.4000/BPStrike price=$1.4000/BP Settlement date=December, 31Settlement date=December, 31 Contract amount=31,250 BPContract amount=31,250 BP No brokerage fees. No brokerage fees.

Jim buys one Jim buys one CallCall option on June, 1 with premium of option on June, 1 with premium of $0.0120/BP$0.0120/BP

Just before expiration, spot rate=$1.4100/BP.Just before expiration, spot rate=$1.4100/BP.

Q1: Will the investor exercise the Call option? Q1: Will the investor exercise the Call option?

Yes. He exercises the Call option and then sell pounds with Yes. He exercises the Call option and then sell pounds with spot rate of $1.4100/BP.spot rate of $1.4100/BP.

Q2: What is his profit/loss?Q2: What is his profit/loss?

(1.4100-1.4000-0.0120)/BP more details in the textbook(1.4100-1.4000-0.0120)/BP more details in the textbook 5151

Speculation with Call Options (2)Speculation with Call Options (2)Q&A 19Q&A 19

Call option premium=$0.03/C$Call option premium=$0.03/C$ Strike price=$0.75/C$Strike price=$0.75/C$ Fill in the net profit(or loss) per unit based on the Fill in the net profit(or loss) per unit based on the

listed possible spot rates of the C$ on the listed possible spot rates of the C$ on the expiration date.expiration date.

5252

Possible spot rate ofC$ on expiration date net Profit (loss)/C$

$0.76 -0.020.78 0.000.80 0.020.82 0.040.85 0.070.87 0.09

Speculation with Put Options (1)Speculation with Put Options (1)example on page 140example on page 140

Strike price=$1.4000/BPStrike price=$1.4000/BP Settlement date=December, 31Settlement date=December, 31 Contract amount=31,250 BPContract amount=31,250 BP No brokerage fees. No brokerage fees.

One investor buy one One investor buy one PutPut option on June, 1 with premium of option on June, 1 with premium of $0.0400/BP. Spot rate on June,1 =$1.3900$0.0400/BP. Spot rate on June,1 =$1.3900

Just before expiration, spot rate=$1.3000/BP.Just before expiration, spot rate=$1.3000/BP.

Q1: Will the investor exercise the Put option? Q1: Will the investor exercise the Put option?

Yes. He will buy pounds from spot market at $1.3000/BP and Yes. He will buy pounds from spot market at $1.3000/BP and then execute the put option.then execute the put option.

Q2: What is his profit/loss?Q2: What is his profit/loss?

(1.4000-1.3000-0.0400)/BP more details in the textbook(1.4000-1.3000-0.0400)/BP more details in the textbook5353

Speculation with Put Options (2)Speculation with Put Options (2)Q&A 20Q&A 20

Put option premium=$0.02/C$Put option premium=$0.02/C$ Strike price=$0.86/C$Strike price=$0.86/C$ Fill in the net profit(or loss) per unit based on the Fill in the net profit(or loss) per unit based on the

listed possible spot rates of the C$ on the listed possible spot rates of the C$ on the expiration date.expiration date.

5454

Possible spot rate ofC$ on expiration date net Profit (loss)/C$

$0.76 0.080.79 0.050.84 0.000.87 -0.020.89 -0.020.91 -0.02

5555

Problems Problems An investor traded two options on euro. The first An investor traded two options on euro. The first

call option has an exercise price of $1.050. The call option has an exercise price of $1.050. The second put option has an exercise price of second put option has an exercise price of $1.100. Both options have the same expiration $1.100. Both options have the same expiration date. Today is the expiration date. At what price date. Today is the expiration date. At what price will the investor receive positive payoff from his will the investor receive positive payoff from his portfolio?portfolio?

5656

Protective put 1 Protective put 1

SS00 = initial currency price = initial currency price P = put option premiumP = put option premiumCost of the position = currency price + put premiumCost of the position = currency price + put premium

= S= S00 + P + P

ST ≤ X ST > X

Payoff of currency ST ST

Payoff of put X – ST 0

Total payoff X ST

Protective put 2Protective put 2

You currently manages 1 million euro cash. You currently manages 1 million euro cash. Today’s spot rate is $1.100/euro. You expect that Today’s spot rate is $1.100/euro. You expect that in the coming year euro will depreciate against in the coming year euro will depreciate against US $. You buy a 12-month euro put option with a US $. You buy a 12-month euro put option with a strike of $1.000 and a premium of $0.0300/euro. strike of $1.000 and a premium of $0.0300/euro. After 3 months, the prevailing spot rate is After 3 months, the prevailing spot rate is $0.9500/euro. $0.9500/euro.

(1)How much is the payoff (value) of your portfolio? (1)How much is the payoff (value) of your portfolio?

(2)If the prevailing spot rate is $0.8000/euro, how (2)If the prevailing spot rate is $0.8000/euro, how much is the payoff of your portfolio? much is the payoff of your portfolio?

(3) what about $1.3000?(3) what about $1.3000?

5757

Homework 6Homework 6

Chapter 5 Q&A: Chapter 5 Q&A: 6,7,10,11,12,13,21,22.6,7,10,11,12,13,21,22.

5858