Suppose Stella wanted the option to buy 10,000,000 at a strike- price of $0.0100

Question

Suppose Stella wanted the option to buy 10,000,000 at a strike- price of $0.0100. For this right, the premium costs 0.2 cents and this option expires in May. The current spot is: $0.0102/. If Stella is looking to hedge, is she the exporter or importer? What will Stella pay now in order to have this option to buy Yen in May? At what strike price will she make money? Lose money? If the spot goes to $0.0083/in May, what should she do with this contract? If the Spot in May is $0.0105/.. should she exercise his contract?

Explanation / Answer

Strike Price for the option to buy 10,000,000 Yen = $ (0.0100 * 10,000,000) = $ 100,000

(1.) Stella wanted the option to buy Yen to hedge herself against the fluctuations in price of Yen at the time of making payment in Yen. Hence, she appears to be an importer as she has to make the payment in yen.

(2.) Stella will pay now the premium costing 0.2 cents ($ 0.002 * 10,000,000 = $ 20,000 ) in order to have the option to buy 10,000,000 Yen in May.

1 cent = 1/100 $

So, 0.2 cents = $ 0.002

(3.) She will be making money until the spot price exceeds the sum of strike price and premium.

i.e. Spot Price > (Strike Price + Premium)

i.e. Strike Price < Spot Price - Premium.

(4.) She will be losing money when the spot price is less than the sum of strike price and premium.

i.e. Spot Price < (Strike Price + Premium)

i.e. Strike Price > Spot Price - Premium.

(5.) Spot Price = $ 0.0083/Yen

i.e. Spot Price for 10,000,000 Yen = $ (0.0083 * 10,000,000) = $ 83,000

Strike Price for 10,000,000 Yen = $ 100,000

Since, Spot Price is less than the strike price, so she should not exercise the option and should buy the Yen directly in the Spot Market. In this case, her loss will be limited to the premium of $20,000 paid by her for purchasing the option.

(6.) Spot Price = $ 0.0105/Yen

i.e. Spot Price for 10,000,000 Yen = $ (0.0105 * 10,000,000) = $ 105,000

Strike Price for 10,000,000 Yen = $ 100,000

Since, Spot Price is more than the strike price, so she should exercise the option.

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