Question

Question 1-3. Assume the following options are currently available for British pounds (₤):

•Call option premium on British pounds = $.04 per unit

•Put option premium on British pounds = $.03 per unit

•Call option strike price = $1.56

•Put option strike price = $1.53

•One option contract represents ₤31,250.

1. At a long strangle position, what is your profit (loss) when spot exchange rate changes to $1.40

1. -$0.04
2. +$0.14
3. +$0.10
4. +$0.06
5. -$0.06

2. What is the profit (loss) you earn from the Call option in the long strangle position, when spot exchange rate changes to $ 1.53

1. -$0.04
2. -$0.03
3. +$0.03
4. +$0.01
5. -$0.01

3. Determine the break-event point (s) for the long strangle

1. $1.53 and $1.56
2. $1.46 and $ 1.56
3. $1.46 and $ 1,63
4. $1.49 and $1.63
5. $1.48 and $ 1.63

Answer 1

Long strangle position involves buying call and a put option at the different strike prices. As in the said question, we have two different strike prices. ($1.56 for call option and $1.53 for the put option).

Thus, Total premium paid = Call premium + Put Premium = $0.04 + $0.03 = $0.07

A. When spot rate changes to $1.40

Now, since the spot rate is $1.40. the call option will not be exercised since the spot rate is below the call option strike price of $1.56.

On the contrary, the put option shall be exercised since the strike price of put option ($1.53) is more than $1.40.

Total Profit on put option = $1.53 - $1.40= $0.13

Net Profit = Toal Pofit - Premium Paid = $0.13 - $ 0.07 = $0.06

The correct answer is Option D (+$0.06).

B. When spot rate changes to $1.53 (In this part, we have to focus on just the call option)

Now, since the spot rate is $1.53. the call option will not be exercised since the spot rate is below the call option strike price of $1.56.

Premium paid for the call option is $0.04.

The correct answer is Option A (-$0.04).

C. Breakeven Points

There are two breakeven points in the long strangle. Upper and Lower Breakeven points. At this point, our net position is nil.

Upper Breakeven Point = Strike Price of Call Option + Premium Paid = $1.56 + $0.07 = $1.63

If this is the strike price, call option shall be exercised and put option will not be, resulting in profit of $0.07 but since premium paid is $0.07. Net profit shall be nil.

Lower Breakeven Point = Strike Price of Put Option - Premium Paid = $1.53 - $0.07 = $1.46

If this is the strike price, call option shall not be exercised and put option will be, resulting in profit of $0.07 but since premium paid is $0.07. Net profit shall be nil.

Thus, the answer is Option C ($1.46 & $1.63)