FINC3240 FINC3240 International International Finance Finance Chapter 5 Chapter 5 Currency Options Currency Options 1
Dec 15, 2015
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