Page 139 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes If the seller of the call option did not obtain francs until the option was about to be exercised, the
net profit to the seller of the call option was:

Per Unit Per Contract
Selling price of SF $.44 $27,500 ($.44 × 62,500 units)
–Purchase price of SF –$.49 –$30,625 ($.49 × 62,500 units)
+Premium paid for option +$.01 +$625 ($.01 × 62,500 units)
=Net profit –$.04 –$2,500 ($.04 × 62,500 units)
When brokerage fees are ignored, the currency call purchaser’s gain will be the seller’s loss. The
currency call purchaser’s expenses represent the seller’s revenues and the purchaser’s revenues
represent the seller’s expenses. Because it is possible for purchasers and sellers of options to
close out their positions, the relationship described here will not hold unless both parties begin
and close out their positions at the same time.

An owner of a currency option may simply sell the option to someone else before the expiration
date rather than exercising it. The owner can still earn profits, since the option premium changes
over time reflecting the probability that the option can be exercised and the potential profit
availed from exercising it.

Break-even Point from Speculation

The purchaser of a call option will break even if the revenue from selling the currency equals the
payments for (i) the currency (at the strike price), and (ii) the option premium. In other words,
regardless of the number of units in a contract, a purchaser will break even if the spot rate at
which the currency is sold is equal to strike price plus the option premium. In the previous
example, the strike price was $1.50 and the option premium was $.012. Thus, in order for the
purchaser to break even, the spot rate existing at the time the call is exercised must be $1.512
($1.50 + $.012). Speculators would not have purchased the call option if they thought the spot rate
would only reach this break-even point without going higher before the expiration date. The
computation of the break-even point is useful for a speculator deciding whether to purchase a
currency call option or not.
Speculators could also attempt to profit from selling currency put options. The seller of such
options is obligated to purchase the specified currency at the strike price from the owner who
exercises the put option. Speculators who believe the currency will appreciate (or at least will
not depreciate) may consider selling a currency put option. If the currency appreciated over the
entire period, the option would not be exercised. This is an ideal situation for put option sellers
since they keep the premiums received when selling the options and bear no cost.

Example: To illustrate how to determine the net profit from speculating with put options,
assume the following information:

Put option premium on British pound = $.04 per unit
Strike price = $1.50
1 option contract represents 32,000 pound.

A speculator who had purchased this put option decided to exercise the option shortly before the
expiration date when the spot rate of the pound was $1.40. The pounds were purchased in the
spot market at that time by the speculator. Given this information, the net profit to the purchaser
of the put option was:

134 LOVELY PROFESSIONAL UNIVERSITY