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 £250,000 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 divided by pound$1.3200/£long —in he coming 30 to 60 days. The current spot rate is $ 1.4260 divided by pound$1.4260/£.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	$	0.00150	/£
$	1.32	/£	60 days	$	0.00060	/£

Answer 1

Issues to consider:

1.In the choice between the maturity days (30 & 60 days). 60 days maturity would be preferred as it will capture the timing of the exhange rate changes

2. Which strike price to consider

-The lower the strike price (1.34 or 1.32), the cheaper the option price.The reason they are cheaper is that they are increasingly less likely to end up in the money

-The choice, given that all the options are relatively "cheap," is to pick the strike price which will yield the required return.The $1.32 strike price is too far 'down,' given that the only expects the pound to fall to about $1.32.

NOTE: this has been worked out in an excel and pasted as a picture for reference