Question

Arthur Doyle is a currency trader for Baker? Street, a private investment house in London. Baker? Street's clients are a collection of wealthy private investors? who, with a minimum stake of pound 240, 000 ?each, wish to speculate on the movement of currencies. The investors expect annual returns in excess of 25%. Although officed in? London, all accounts and expectations are based in U.S. dollars. Arthur is convinced that the British pound will slide significantly - possibly to $ 1.3200 - in the coming 30 to 60 days. The current spot rate is $ 1.4257. Arthur wishes to buy a put on pounds which will yield the 25?% return expected by his investors. Which of the following put options would you recommend he? purchase? Prove your choice is the preferable combination of strike? price, maturity, and? up-front premium expense.

Strike Price			Maturity	Premium
$	1.36	/£	30 days	$	0.00081	/£
$	1.34	/£	30 days	$	0.00021	/£
$	1.32	/£	30 days	$	0.00004	/£
$	1.36	/£	60 days	$	0.00333	/£
$	1.34	/£	60 days	$	0.00151	/£
$	1.32	/£	60 days	$	0.00061	/£

The return on investment? (ROI) at the strike price of ?$1.36

The return on investment? (ROI) at the strike price of $1.34

The return on investment? (ROI) at the strike price of $1.32

?

Answer 1

Calculation of strike price at 30 days out option

Return on investment at the strike price$1.36£ = (Current spot rate- Strike price- Premium paid)/Current spot rate * 365/Number of days

Return on investment at the strike price$1.36£ = (1.4257- 1.36- .00081)/1.4257*365/30=.5537 or 55.37%

Return on investment at the strike price$1.34£ = (1.4257-1.34- .00021)/1.4257*365/30=.7295 or 72.95%

Return on investment at the strike price$1.32£ = (1.4257-1.32- .00004)/1.4257*365/30= .9016 or 90.16%

Calculation of strike price at 60 days out option

Return on investment at the strike price$1.36£ = (Current spot rate- Strike price- Premium paid)/Current spot rate * 365/Number of days

Return on investment at the strike price$1.36£ = (1.4257- 1.36- .00333)/1.4257*365/60=.2661 or 26.61%

Return on investment at the strike price$1.34£ = (1.4257-1.34- .00151)/1.4257*365/60=.3592 or 35.92%

Return on investment at the strike price$1.32£ = (1.4257-1.32- .00061)/1.4257*365/60=.4484 or 44.84%

Purchase preference:

30 days put option at the strike price$1.32£ where ROI is 90.16%

60 days put option at the strike price$1.32£ where ROI is 44.84%