Question

 Calandra Panagakos works for CIBC Currency Funds in Toronto. Calandra is something of a contrarian—as opposed to most of the​ forecasts, she believes the Canadian dollar​ (C$) will appreciate versus the U.S. dollar over the coming 90 days. The current spot rate is ​$0.6746​/C$. Calandra may choose between the following options on the Canadian​ dollar:

Option	Strike Price	Premium
Put on​ C$	​$0.7006	​$0.00004​/C$
Call on​ C$	​$0.7006	​$0.00045​/C$

a. Should Calandra buy a put on Canadian dollars or a call on Canadian​ dollars?

b. What is​ Calandra's breakeven price on the option purchased in part a​?

c. Using your answer from part a​, what is​ Calandra's gross profit and net profit​ (including premium) if the spot rate at the end of 90 days is indeed ​$0.7603​/C$?

d. Using your answer from part a​, what is​ Calandra's gross profit and net profit​ (including premium) if the spot rate at the end of 90 days is ​$0.8252​/C$?

Answer 1

Solution:

A/- Calandra should buy a call option of strike price given C$$ 0.7006 on canadian dollars. She believes that CAD will appreciate against the US Dollar, thus she should long currency, hence call option is preferred.

B/- As the strike price is greater then the spot price, call option is Out of Money(OTM).

Breakeven price = Strike price + premium = 0.7006 + 0.00045 = 0.7010

Post C$$ 0.7010 , buyer will start earning profit.

C/- End of 90 days, spot price is C$$ 0.7603.

Gross Profit = spot price - strike price = 0.7003 - 0.7006 = C$$ 0.0003 (Answer)

Net Profit = As spot price C$$ 0.7003 is below the breakeven price of  C$$ 0.7010, premium paid is the loss

i.e 0.00045 (Answer)

D/-

End of 90 days, spot price is C$$ 0.8252

Gross Profit = spot price - strike price = 0.8252 - 0.7006 = C$$ 0.1246 (Answer)

Net Profit = As spot price C$$ 0.8252 is above the breakeven price of  C$$ 0.7010,  

0.8252 - 0.7010 = C$$ 0.1242 (Answer)

i.e 0.00045 (Answer)