Question

Consider a European call option on €62,500 with an exercise price of $1.50/€. You pay an option premium of $0.10/€ for the call option today.

a. If the $-€ spot exchange rate is $1.62/€ on the contract expiration date, would you exercise the call option (buy € at the exercise price at expiration)? What would be the option payoff and profit?

b. If the $-€ spot exchange rate is $1.45/€ on the contract expiration date, would you exercise the call option? What would be the option payoff and profit?

c. At what $-€ spot exchange rate at expiration would you break-even (profit=0)?

d. Draw a profit profile of buying the call option.

Answer 1

a]

A call option would be exercised if the underlying price at expiration is higher than the option strike price.

You would exercise the option as the underlying price at expiration is higher than the option strike price.

Payoff = (underlying price at expiration - option strike price) * contract size = ($1.62 - $1.50) * €62,500 = $7,500

Profit = (underlying price at expiration - option strike price - premium) * contract size = ($1.62 - $1.50 - $0.10) * €62,500 = $1,250

b]

You would not exercise the call option as the underlying price at expiration is lower than the option strike price.'

Loss = premium paid = premium * contract size = $0.10 * €62,500 = $6,250

c]

Breakeven price = option strike price + premium

Breakeven price = $1.50 + $0.10 = $1.60/€

d]

AB Underlying Long Call price at Profit 1 expiration ($1.50) 2 $ 1.45 $(6,250.00) 3 $ 1.46 $(6,250.00) 4 $ 1.47 $(6,250.00) 5 $ 1.48 $(6,250.00) 6 $ 1.49 $(6,250.00) 7 $ 1.50 $(6,250.00) 8 $ 1.51 $(5,625.00) 9 $ 1.52 $(5,000.00) 10 $ 1.53 $(4,375.00) 11 $ 1.54 $ (3,750.00) 12 $ 1.55 $ (3,125.00) 13 $ 1.56 $(2,500.00) 14 $ 1.57 $(1,875.00) 15 $ 1.58 $(1,250.00) 16 $ 1.59 $ (625.00) 17 $ 1.60 $ 0.00 18 $ 1.61 $ 625.00 19 $ 1.62 $ 1,250.00 20 $ 1.63 $ 1,875.00 21 $ 1.64 $ 2,500.00 22 $ 1.65 $3,125.00 23 $ 1.66 $ 3,750.00 24 $ 1.67 $ 4,375.00 25 $ 1.68 $ 5,000.00 26 $ 1.69 $ 5,625.00 27 $ 170 $ 6.250.00

Long Call Profit ($1.50) $8,000.00 $5,000.00 $4,000.00 $2,000.00 $1.45$1.46$1.47$1.48$1.49$1.50$151152153154$1.55$1.56$1.57$138$1.59$1.50$1.61$1.62$1.63$1.64$1.65$1.66$1.67$1.58$1.59$1.70 $(2,000.00) $(4,000.00) $(6,000.00) $(8,000.00)