Assume that a British pound pu
Assume that a British pound put option has a premium of $.03 perunit and an exercise price of $1.60. The present spot rate is$1.61. The expected future spot rate on the expiration date is$1.52. The option will be exercised on this date, if at all. Whatis the expected per unit net gain (or loss) resulting frompurchasing the put option?
Answer:
| Solution: | ||||
| $0.05 is the expected per unit net gain | ||||
| Working Notes: | ||||
| Put option is valuable when expected expiry spotrate is lower than exercise price | ||||
| the expected perunit net gain (or loss) resulting from purchasing the put optionwill be the difference of exercise price and expected future spotrate and net of premium paid for the put option. | ||||
| i.e. Net gain (loss) = exercise price -future expected spot rate – premium paid | ||||
| Net gain (loss) = $1.60 – $1.52 -$.03 | ||||
| Net gain = $0.05 per unit | ||||
| Notes: | In Put optionbuyer got the right to sell the underlying at exercise price whenprice is lower than exercise price, means buyer of put option willreceived the difference of exercise price & spot price atexpiry if lower than exercise price , and buyer is to pay premium1st at the time of buying the put option. | |||
| Please feel free to ask ifanything about above solution in comment section of thequestion. | ||||
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