Suppose that instead of using a forward contract, you consider using options. A one-year call option to buy euros at a strike price of $1.25/€ is trading for $0.10/€. Similarly a one year put option to sell euros at a strike price of $1.25/€ is trading for $0.10/€. To hedge the risk of your profits, should you buy or sell the call or the put?

Question

Harley

Business

13 June, 00:20

Suppose that instead of using a forward contract, you consider using options. A one-year call option to buy euros at a strike price of $1.25/€ is trading for $0.10/€. Similarly a one year put option to sell euros at a strike price of $1.25/€ is trading for $0.10/€. To hedge the risk of your profits, should you buy or sell the call or the put?

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Answers (1)

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Adison Webb · Answer 1

Sell the put option. The put option is better and advantageous.

Explanation:

The call option is trading far below the strike price and poses risk. The price may not go up to $1.25 and hence not advisable. The put option is better as we stand to make a profit margin ($1.15 / Euro) if it sells the put at he strike price immediately. Given that the difference is high, it is unlikely that the price will move against us and we shall exercise the option as soon as the margin starts reducing.