ADMS 1000 Lecture Notes - Lecture 8: Spot Contract, Canadian Dollar

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blushweasel304

6 Jul 2018

School

York University

Department

Administrative Studies

Course

ADMS 1000

Professor

Alan Shapiro

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The lower the spot rate relative to the strike price, the more valuable the put option will be because there is a greater probability that the option will be exercised. To insulate itself against such depreciation, duluth purchases canadian dollar put options that entitle the company to sell canadian dollars at the specified strike price. In essence, duluth locks in the minimum rate at which it can exchange canadian dollars for u. s. dollars over a specified period of time. If the canadian dollar appreciates over this period, then duluth can let the put options expire and simply sell the canadian dollars it receives at the prevailing spot rate. The spot rate relative to the strike price, the more valuable the put option will be because there is a greater probability that the option will be exercised. Recall that just the opposite relationship held for call options.

Related Questions

1.Consider the following portfolio: You buy two July 2009 maturity call options on Dell with exercise price of 30. You also sell two July 2009 maturity put options on Dell with an exercise price of 40. The Call premium is $3.30 and the Put premium is $2.50.

Assume each option contract is for one share of stock.

e. What will be your profit/loss on this position if Dell is selling at $42 on the option maturity date?

f. What will be your profit/loss on this position if Dell is selling at $38 on the option maturity date?

g. At what stock price on the option maturity date will you just break even on your investment?

Make sure that you show or explain all calculations. Make sure you answer all questions above.

2- Consider an option on a non-dividend-paying stock when the stock price is $48, the strike price is $45, the risk-free interest rate is 6% per annum, the volatility is 20% per annum, and the time to maturity is five months. It can be shown that d1 = .7576 and d2 = .6285.

Create a delta neutral portfolio of call options and stock. Short 10,000 call options (100 contracts). How many shares would you buy or sell?

Make sure that you show or explain all calculations. Make sure that you state the number of shares. Make sure that you state whether you would buy or sell the shares

You are offered a chance to by a put or call option from a currency dealer with a strike price of USD 0.8300/CHF with June expiration and premium of USD 0.0050/CHF. Your Magic 8 Ball tells you that the spot exchange rate will reach USD .8400/CHF sometime between now and June. With USD 100,000 you found, you want to make as much speculative profits as possible using FX options.

A) Carefully derive and draw the profit functions on the two options to help you decide. Be sure to carefully label all axes, strike price, and the break-even point. Which option should you purchase? Exactly which transaction must you carry out and when in order to make the speculative profits?

B) If you used all of the USD 100,000 to speculate on the option you suggested in part A, what are your:

Total Net Profits

Notional Principal

The rate of return on this speculation assuming your Magic 8 Ball is right? (What is your loss if the Magic 8 Ball is wrong?)

Here is a quote from an investment website about an investment strategy using options:

One strategy investors are applying to the XYZ options is using âsynthetic stock.â A synthetic stock is created when an investor simultaneously purchases a call option and sells a put option on the same stock. The end result is that the synthetic stock has the same value, in terms of capital gain potential, as the underlying stock itself. Provided the premiums on the options are the same, they cancel each other out so the transaction fees are a wash. (as cited in McDonald, 2013, question 3.19)

Suppose, to be concrete that the premium on the call you buy is the same as the premium on the put you sell, and both have the same strikes and times to expiration.

a. What can you say about the strike price?

b. What term best describes the position you have created? What is the shape of the profit diagram?

c. Suppose the options have a bid-ask spread. If you are creating a synthetic purchased stock and the net premium is zero inclusive of the bid-ask spread, where will the strike price be relative to the forward price?

d.If you create a synthetic short stock with zero premium inclusive of the bid-ask spread, where will the strike price be relative to the forward price?

e. Do you consider the âtransaction feesâ to really be âa washâ? Why or why not?

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ADMS 1000 Lecture Notes - Lecture 8: Spot Contract, Canadian Dollar

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