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Hi John,
Question 53 in BPP revision kit (sept 2018) requirement c (i), the solution for options contract does not show what the spot rate in order to decide if the option should be exercised or not. Would the spot rate after 7 months be equal to the seven-month expiry for future (125.2) as future moves towards spot which eventually leads to 0 (zero) basis? If not then can you please advise how the spot rate would be determined?
Since the option is exercised so can you please advise how to obtain the value of JPY 10,080 m using the method shown in the lecture -contracts x contract size x (exercise price – spot price)? In this case would we be getting amount back from the dealer?
Thank you
We cannot calculate either the spot rate or the futures price in 6 months time (the date the proceeds are received). We do know the current spot rate and the current futures price and therefore the basis. The basis will fall over the life of the future but we would need to know either the spot rate or the futures price in 6 months time to be able to calculate the other.
For this reason, as I explain in my lectures, we have to use the lock-in rate for the futures (125.8) which gives the net effect of converting the transaction at spot together with any gain or loss on the futures.For the same reasons, we cannot show full workings for the option deal (we would need to know the spot on the date of the transaction and we do not know it). Therefore all we can do is state the ‘worst’ outcome resulting from the use of the options (i.e. if the options are exercised).
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