Question

Consider the following option contract on the Euro:

It is a call option for 125,000 euros, but here the settlement prices are in terms of Swiss franc per one euro (i.e., if exercised, €125,000 will be delivered in exchange for the appropriate number of francs) The strike price is 1.07 franc per euro, and the premium is 0.0060 franc per euro.

1. Suppose a trader writes one of these call option contracts. What would be the trader’s profit or loss if the spot rate upon the option expiration is 1.0800 francs per euro?
2. A different options trader purchased one of these call option contracts. What would be the profit or loss if the spot rate upon the option expiration is 1.0600 francs per euro?
3. Another trader wrote two of these put option contracts. What would be this trader’s profit or loss if the spot rate upon the option expiration is 1.0500 francs per euro?
4. Suppose that soon after taking these positions (but before their expiration), the value of the euro would appreciate substantially, well beyond expectations. Would it benefit the long position in this option or the short position?

Answer 1

.(a) Writing one call option:

Amount of Euros on contract=€125,000

Amount received for writing the contract=125,000*0.0060 Franc=750 Franc

Strike Price=1.07Franc/Euro

Payoff per EURO for Call Option =Min.((1.07-S),0) Franc

Where S=Spot rate at expiration=1.0800

Payoff per Euro=(1.07-1.08)=-0.01Franc

Total Payoff =125000*0.01=-1250 Franc

LOSS=Payoff+750=-1250+750=-500 Franc

.(b)

For Purchase of one call option:

Amount of Euros on contract=125000

Cost of contract purchase=125000*0.006=750 Franc

Payoff per EURO =Max.((S-1.07),0)Franc

Where S=Spot rate at expiration=1.06 Franc/Euro

Payoff per Euro=0

LOSS=0-750=-750 Franc

.(c)

For Writing of TWO PUT options:

Amount of Euros on contract=2*125000=250,000

Amount received from contract purchase=250000*0.006=1500 Franc

Payoff per EURO =Min.((S-1.07),0)

Where S=Spot rate at expiration=1.05

Payoff per Euro=1.05-1.07=-0.02

Total Payoff for the contract=-250000*0.02Franc=-5000Franc

LOSS=-5000+1500=-3500 Franc

.(d)

If value of Euro appreciates, more Francs will be needed per EURO

Franc per Euro rate will go up.

Since Value of spot rate will go up, the Call premium will go up

This will be beneficial for Long position in the Call Premium

But it would not benefit Put option long position