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Hello Sir,
Hope you are safe and well.
Can you please help me with part (a) using options only? I am unable to calculate the net gain or loss whilst closing futures.
Are you looking at the original exam question or are you looking at it in a Revision Kit?
The reason I ask is that in the original question there are no futures available – the choices are to use forward rates, to use the money markets, or to use options.With traded options, then strictly the transaction should be converted at whatever spot happens to be on the date of the transaction. If there is a gain comparing the spot rate and the exercise price then the option will be exercised. (There is never a loss because if there were then the option would simply not be exercised)
Here, we do not know what the spot rate is on the date of the transaction and therefore if the option is exercised then we must simply convert the contract amount at the exercise price.
Why do we calculate two excerside price option ? Even if we do qe arent hedging the amount while using 1.60 as exercise price but we are hedging while using 1.62 as exercise price? Could you plrase explain me the reason behind this ?
There are two exercise prices available and so to be able to advise we should look at the outcome for both of them.
Options have to be dealt with in fixed sized contracts. At 1.60 it comes to an exact number of contracts. At 1.62 it does not come to an exact number, so an amount is left unhedged and we will use forward rate on that amount.
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