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Dear John
Can you please explain for my understanding purpose Why the options are not exercised on exercise price of 1.36. Since its a call option we buy call option at exercise price of 1.36 however the furture price on transcation date is 1.31714 according to solution. So if we bought at 1.36 we must sell at 1.31714 to make profit. Or maybe i am wrong somewhere. Can you explain that with relevant workings ?
Same problem with exercise price of 1.38.
Thanks in Advance.
You do not buy the option for 1.36
You buy the option and pay a premium.
You then have the right to buy futures at 1.36 on the date of the actual transaction. If the futures price is higher than 1.36 then you exercise the option, buy the futures at 1.36 and immediately sell them and make a gain.
If the futures price is lower than 1.36, then you simply ‘throw away’ the option and do not exercise.Dear John this is what exactly i meant but i didnt get this.
In option we buy the right to buy future @ excercise price. Since it was a call option in question we have the right to buy at excercise price of 1.36 and sell immediately at future price on transcation date i.e. 1.3714. We can make profit of 0.0114 by excercising the option. So my question is why the examiner has not exercised the option in solution ?
Please explain specifically related to this question.
Thanks in advance:)
Sorry – I didn’t look at the question itself because I assumed you had typed correctly (which you hadn’t 🙂 You typed the futures price as being 1.31714, not 1.3714 !!)
Having now check the question, I don’t know why you say that the options have not been exercised. They have been exercised.
Instead of showing separately conversion at spot and then profit on options, the examiners answer has converted at the option rate instead of the spot rate which is the valid alternative) because they are being exercised.Soory John i was having your format in mind while i was solving this and i was confused because the answer didnt show profit or loss on option exercised that’s why i said that.
John first of all thanks a lot for bearing patience with me and clearing my concept here.
One last thing which i want to confirm from you. Since we are not given interest rates and period of investing for $20m reciepts. So the $20m reciepts are converted on exercise price of $1.36 which means option is exercised.
So if the amount is converted on exercise price on transcation date it means option is exercised and profit or loss on option are already included in it. ( Just like did in this question). So we dnt need to calculate profit or loss on options again separately. I can do same like this in exam as valid alternative like you said.
Am i rite here John ?
Hello John. Hope u re doing well. I have one question regarding to options hedging in Casasophia. May i know why do we divide the amount with spot rate of $1.3585 rather than spot rate of $1.3618 upon calculating the premium for the options. As what i learn so far, i believe we should divided by $1.3618. A bit confused here.
hope u can enlighten me. thankyou and stay safe 🙂
They are paying the premium. The premium is in $’s and so they need to buy $’s in order to pay the premium. When buying $’s we use the lower exchange rate. (Converting at the higher rate would mean it would cost less. That cannot be the case – it is the banks who profit out of the spread 🙂 )
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