Question

A call option on the SGD with a strike price of 0.73 USD/SGD and a maturity of 6 months has a premium bid price of 0.07 USD, and a 1penny bid-ask spread. If you sell these options today on 10,000 SGD, and at maturity the SGD is quoted at bid price of 0.89 USD/SGD, with a 1 penny bid-ask spread, what is your net profit on this position?

Note: pay careful attention to which side of the quote you will be trading with at each step.

Answer 1

Bid price is the price at which market is willing to buy the underlying asset. Therefore, since you are selling to the market, you will use the bid price (think of you and market as different). Ask price is the price at which the market is willing to sell the underlying asset. Therefore, you will use the ask rate when buying the asset.

Now, when trading on option you pay the premium on option. So, any net profit would be based on premium on options. Also, bid-ask spread is the difference or amount by which the ask price is greater than the bid price.

At time of purchase

Bid price = USD 0.07

Ask price = Bid price + bid-ask spread = USD 0.07 + USD 0.01 = USD 0.08

Purchase price = SGD 10,000 x USD 0.08 / SGD = USD 800

At time of sale

Bid price (premium) = SGD price - strike price = USD 0.89 - USD 0.73 = USD 0.16

Sale price = SGD 10,000 x USD 0.16 / SGD = USD 1,600

Net profit = USD 1600 - USD 800 = USD 800