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ACCA P4 Question 1 June 2014 part 2
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Hello John, I understand about choice between call or put options. In the answer, it say sell put options. What I still don’t understand is when to buy or sell. In this case, why sell put options rather than buy put options? I couldn’t hear that explained in the video. Thank you.
Hi John why we have not calculated gain or loss on futures
In options why we have not taken the spot rates by taking the basis and why here also we have not calculated profit or loss on options
We cannot calculate the gain or loss on the futures because we do not know the futures price on the date of the transaction.
So (as usual) we have used the lock-in rate which I explain in my lectures, and this calculates the net effect of converting the transaction at spot together with the gain or loss on the futures.
We do not know the spot rate on the date of the transaction and so we cannot calculate a gain or loss on the options.
Thanks John that clarifies the doubt
Hi John,
Why does the examiner’s answer use the lock-in rate 1.0651 to calculate the number of contracts instead of using the future price of 1.0659?
Thank you
Actually it is the question for the Futures part.
For the Options part, I read some where that we should always round down the number of contracts and hedge the un-hedged amounts. Then in the option choice of exercise price 1.07, is there any problem that I round down the contracts to 37 and hedge the rest of the amount using forward rate?
Thank you
First question: It doesn’t matter – there is a logic to both (and the number of contracts will either be the same or will not be much different).
Second question: It is not a rule to round down (but it doesn’t matter). I always round to the nearest contract and then use the forward rate on the over or under hedge. (Using the forward rate on the over or under hedge is a minor point in terms of the marks – do it if you have time. If not then just mention it.)
The question asked us to demonstrate.. if it had asked to evaluate and recommend, would using your approach (worst outcome) on the option contract be on the right path?
Yes it would 馃檪
Life saver ! I was strugling to understand the options calculation by myself with no result. Now all is clear.
Biiiig big thanks.
You are welcome 馃檪
Sir what if I want to predict the spot rate on the date of transaction that will be in 4months time what arithmetic will be involved in it
To forecast a spot rate you use the purchasing power parity formula.
Sir specific ti this question we don’t know the inflation its only told to be 3 times higher than swiss so how can I predict spot rate
That is why in this question we cannot predict the spot rate and are not required to.
ok thanks
You are welcome 馃檪
my question here is we will come to that we are under or over hedge when we exercise the options either 1.6 or 1.07 and on exercise date the forward rate could be different from what he has given in the exam question so show can we convert the under or over hedge amount using the given forward rate which could not be valid by that time.
You know ‘now’ what the amount of the over or under hedge is going to be. Therefore you would use ‘today’s’ forward rate, and that is then fixed.
Hi John
is it okay to use the lock in rate as the spot rate for the option hence leave the option to lapse at 1.60 and exercise at 1.70 making a slight gain on that?
No. The lock in rate is not a forecast of the futures price – it is a forecast of the net effect on converting at spot and the profit or loss on the futures deal.