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Sorry to bother you again John,
I still confused with this question. even it’s OTC option, the basic concept should be the same. If the actual exchange rate is lower than exercise price, we should exercise the put option; while if the actual rate is higher, don’t exercise the put option, but should exercise call option. The difference between OTC and traded options is: gain/loss is paid by the bank for OTC options, or paid by counterparty/trading company who trades opposite position in the open market for trading options.
However, the examiner exercised the put option when the actual rate is higher than exercise rate, it seems to say Buryecs sell 1€ to the bank and get $7.25 in return while B could sell 1€ in the market and get $7.6046 back. It doesn’t make sense. Do you have better explanation for his answer? thanks.
The examiner’s answer is more like a bank guarantee on exchange rate rather than put options.
But they are not selling €’s !!
They are receiving $’s and selling $’s in order to receive €’s. The put options are the right to sell $’s at a fixed rate and therefore the lower the rate the more they will receive.
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Hi John,
The choice between Call/Put option confused me for a long time. Could you help to identify the logic mistake below? thanks!1. Generally i would firstly choose the ‘product (currency to be traded)’ from the quote ( € in this case, as ‘exercise price quotation is in Wirtonia $ per €1’);
2. So the currency for trading is ‘€’, and Buryecs should buy Call/Put option of ‘€ ‘;
3. As Buryecs is to receive $ 5,000 Million, and need to change to €, so the Call Option of € should be the correct choice – to sell $ and buy €.They are receiving $’s and so they need to sell $’s and buy Euros.
So they can either buy $ put options (the right to sell $’s) or buy Euro call options (the right to buy Euros).
In this question, the options are question in $’s per Euro, so they are $ options and therefore they will buy the $ put options.
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Hi John,
What I fail to understand is the last part in your reply – if ‘$’s per €’ could be used to tell it’s a $ option, the ‘ € per $1’ quotation in Mar/June 2016 Q1 (receipt of 20 Million €) should be identified as a € option, then we should purchase € Put option, but the answer suggest to purchase Call option.
So how to tell an option is for what currency? thanks!
Best regards,
WayneIn the 2017 exam question, the options are OTC options and are specifically quoted as being $’s per Euro.
In the 2016 question they are traded options, and for traded options the relevant currency is the currency that the contract size is quoted in (which in this question is $’s).
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Thanks John.
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