Question

3. (a) Define currency options contract. What are put and call options? (b) You bought a Dec. 20 call option on Australian dollar with a strike price (K) of $0.7850/A$ in June 20 and paid a premium of $0.02/A$. The current spot exchange (S) rate for A$ is $0.7920/A$. (i) What are the intrinsic and the time values of this option? (ii) (a)What is the profit/loss if the option is exercised at expiration if the spot rate settles at $0.8000/A$? (b) if the spot rate settles at $0.7800? The U.S. interest rate is 2%.

Answer 1

(a) Define currency options contract. What are put and call options?

The currency options contracts are rights but not the obligation to exchange (buy or sell) one currency into another at a pre-determined exchange rate at a pre-determined timeline.

A call option gives the holder right but not the obligation to buy one currency using another, at a pre-determined exchange rate at a pre-determined timeline.

A put option gives the holder right but not the obligation to sell one currency for another, at a pre-determined exchange rate at a pre-determined timeline.

(b) You bought a Dec. 20 call option on Australian dollar with a strike price (K) of $0.7850/A$ in June 20 and paid a premium of $0.02/A$. The current spot exchange (S) rate for A$ is $0.7920/A$. (i) What are the intrinsic and the time values of this option? (ii) (a)What is the profit/loss if the option is exercised at expiration if the spot rate settles at $0.8000/A$? (b) if the spot rate settles at $0.7800? The U.S. interest rate is 2%.

(i) Intrinsic value of the option = S - K = $0.7920/A$ - $0.7850/A$ = $ 0.0070 / A$

Time value of the option = C - intrinsic value = 0.02 - 0.0070 = $ 0.0130 / A$

(ii) (a) Profit / (Loss) = max (S - K, 0) - C = max (0.8 - 0.7850, 0) - 0.02 = - $ 0.0050 / A$

(b) Profit / (Loss) = max (S - K, 0) - C = max (0.7800 - 0.7850, 0) - 0.02 = - $ 0.02 / A$