Question

As we discussed the call options, there are three situations where the buyer could be facing any time during the period of the option and at the exercise time, and where he stands financially, should he decide to exercise . In the money , at the money and out of the money. Please use those situations and assume an example in monetary amount within two types of currencies exchanged (between two countries). Under what conditions should the buyer exercise or not exercise?

Answer 1

• An in-the-money call option means the option holder has the opportunity to buy the underlying asset below its current market price i.e. buying at a low price.
• An out of the money call option means the strike price of the option is higher than the current market price of the underlying asset.
• An at the money call option means the strike price of the option is the same as the current market price of the underlying asset.

Let us consider the option of buying 1USD for INR70 which is the strike price of the option with an expiry of 30th Sept 2020.

Now, there might be three cases;

1. The exchange rate is below 1USD/70INR

2. The exchange rate is above 1USD/70INR

3. The exchange rate is 1USD/70INR

In the first case, let say the exchange rate is 1USD/65INR. As the spot rate of dollar is lesser than the price mentioned in the option hence this is an out of the money situation and the option must not be exercised.

In the second case, let say the exchange rate is 1USD/80INR means the spot rate of the dollar is higher than price mentioned in the option, hence it is an in the money situation and the option must be exercised in this situation.

The third case is an example of at the money where the strike price is equivalent to the spot price. Hence it makes the option indiffrent.