Question

An option speculator anticipates the Danish kroner will appreciate from its current level of $.15 to $.17. Currently, kroner call options are available with an exercise price of $.16 and a premium of $.01

(1) Should the speculator buy this option?

(2) If the future spot rate of the Danish kroner is $.17, what is his profit or loss per unit?

Please show how answer is derived.

Answer 1

The anticipated future price is $0.17

Call Exercise Price = $0.16

It means that the option holder will be able to buy Danish Kroner at $0.16 on maturity. Option Premium = $0.01

So, effectively the investor will be paying = $0.16+$0.01 = $0.17 and selling it for $0.17 (if the anticipation is correct) will give him 0 profit.

1. Hence, the speculator should not buy the option

2. Profit or Loss per Unit:

Selling Price $0.17

Less: Buying Price $0.16

Less: Premium Paid = $0.01

Profit/(Loss) = $0