Question

3. A U.S. importer has to make a euro500,000 payment to an Italian exporter in 60 days. They decide to purchase a European call option on euros with the following details:

• Contract size: euro250,000

• Exercise price: $1.45/euro

• Call option premium: $0.04 per euro

What is the overall profit/loss given the following future spot rates? Should the importer exercise the option in each scenario?

A) $1.40/euro

B) $1.45/euro

C) $1.49/euro

D) $1.52/euro

Answer 1

The importer has euro payables worth 500000 due in 60 days. This implies that the importer will need to purchase euros after 60 days. Buying a call option would allow the importer to purchase these euros at the option's strike price irrespective of the $/eur exchange rate after 60 days.

Contract Size = 250000 euro, Exercise Price = $ 1.45/eur and PRemium = $ 0.04/eur

Number of Contracts Bought = 500000 / 250000 = 2 and Premium per Contract = 0.04 x 250000 = $ 10000

(A) If Spot Price is $ 1.4/eur, then the importer will purchase 500000 euros from the market and will not exercise the option. Hence, overall loss = total option premium paid = 2 x 10000 = $ 20000

(B) If Spot Price is $ 1.45/eur, then the importer will purchase 500000 euros from the market and will not exercise the option. Hence, overall loss = total option premium paid = 2 x 10000 = $ 20000

(C) If Spot Price is $ 1.49/EUR,then Call Option Payoff = 1.49 - 1.45 = $ 0.04/eur

Therefore, Overall Profit = 0.04 x 500000 - 20000 = $ 0

(D) If Spot Price is $ 1.52/EUR,then Call Option Payoff = 1.52 - 1.45 = $ 0.07/eur

Therefore, Overall Profit = 0.07 x 500000 - 20000 = $ 15000