Question

Amanda works in the currency trading unit of Sumara Workers Bank in Togliatti, Russia. Her latest speculative position is to profit from her expectation that the U.S. dollar will rise significantly against the Japanese yen. The current spot rate is ¥120.00/USD$. She must choose between the 90-day options on the Japanese yen. The premium is 2.75 yen per USD. a. Should Amanda buy a put on yen or a call on yen? b. What is Amanda's break-even price on her option of choice in part a)? c. What is Amanda's gross profit and net profit if the end spot rate is 140 yen/$?

Should it be a put option? Because USD will rise significantly, we expect it to be 120+ Yen/USD right?
The breakeven will then be 122.75 and the gross and net profit will be 20Yen/USD and 17.25 Yen/USD respectively right?

Answer 1

The rates given in the question are,

Current Spot Rate = Yen 120 per USD

Premium for 90 day options = Yen 2.75 per USD

a. Amanda expects US Dollar to rise significantly against Japanese Yen. Thus, she expects that the Yen per dollar price will rise significantly.

We assume that the Current Spot Rate is the Exercise Price. A buying a call option gives a right to buy underlying and a put option gives a right to sell underlying at the exercise price. Thus, buyer of call option profits if the price of underlying goes up and a buyer of a put option profits if the price of underlying goes down.

As Amanda expects US Dollar to rise significantly , she should buy a call option on Yen per Dollar and not a put option.

b. Breakeven price for the call option = Exercise Price + Option Premium

                                                           = 120 + 2.75

                                                           = 122.75 Yen per USD

c. If the end spot rate is 140 Yen per USD, then

Gross Profit = End Spot Rate - Begin Spot Rate = 140-120 = 20 Yen per US Dollar

Net Profit = Gross Profit - Option Premium = 20 - 2.75 = 17.25 Yen per US Dollar.