Question

Mr. Curtis was enlightened by the information you provided but would like to learn if there are alternative methods available for dealing with currency risks. He requests that you research material from the Library and/or the Internet to construct a memo of 2–3 pages on the differences between buying a call option, selling a call option, buying a put option, and selling a put option. Also, give an example of a business scenario in which it would be appropriate to use each of the contracts (a put and a call contract). If, instead, you chose to use the forward market, assume you were going to receive 100,000 Japanese yen in 6 months, and the current exchange rate is 5 yen to 1 U.S. dollar. How many yen would you sell or buy in the forward market? Be sure to cite all references using the appropriate citation format.

Answer 1

1. Buying a call option gives the buyer the right but not the obligation to buy the underlying asset at a predetermined date and price (long call)
2. Selling a call option gives the seller immediate premium amount from the buyer and the seller is obligated to sell the underlying asset to the buyer at a predetermined price if and only if the buyer exercises his/her rights (short call)
3. Buying a put option gives the buyer the right but not the obligation to sell the underlying asset at a predetermined price (long put)
4. Selling a put option gives the seller immediate premium amount from the buyer and the seller is obligated to buy the underlying asset from the buyer at a predetermined price if and only if the buyer exercises his/her rights (short put)

• Business example -

1) Suppose a farmer in Dec 2019 is cautiouof the Covid-19 situation and was farming a luxury crop and was afraid of prices falling down for that particular crop in the next 6 months. The farmer gets into a forward contract with a businessman and buys the right to sell these crops after 6 months at the current price (Dec 2019 price) This contract would be similar to the options contract (Long put)

In May 2020 the crops price fell and the farmer exercises his rights. Now the farmer will sell these crops to the businessman at the price agreed in Dec 2019 (mentioned in the contract) which is much higher than the market price in May 2020 and the businessman is obliged to buy it from the farmer at that price. The farmer hence hedged his position by burying such a contract at a premium from the businessman. Here the farmer is going Long put and the businessman is short put.

2) Taking the same above situation, The businessman buys a contract from the farmer to purchase certain essentials crops and paying the farmer premium amount. (Long call)
At the later date the prices have risen so the businessman buys crops from the farmer at the rate decided earlier which would be cheaper than the current market rate and sell it in the market at the current market price for a good profit.

Here the businessman is going Long call and the farmer is going Short call.

• Currency forwards

1. If I believe that dollar will depreciation against yen in 6 months for example being able to buy a dollar with only 4 yen in 6 months then I would sell a contract 6 months prior which would let the counterparty buy 1 dollar from me for 5 yen (Similar to short call)
2. If I believe that Yen will depreciation against US Dollar in 6 months for example being able to buy 6 Yen with only 1 US dollar in 6 months then, I would buy a contract 6 months prior which would let me sell 5 Yen for 1 dollar (Similar to long put)