+
Roll Back the Barrel
CTN plc has a problem. Some time ago it issued a purchase order for some
equipment from the United States. Payment for the equipment and for the
shipping costs are due when the ship reaches a British port. The arrival date is
uncertain because, to keep costs down, the equipment has not been shipped on
a liner service but by a tramp operator, operating out of Seattle. The many ports
passed on the way, the negotiation of the Panama Canal and the vagaries of the
Atlantic weather mean that it is extremely difficult to determine the exact arrival
date and hence payment date.
The equipment was shipped two weeks ago and that means that it could arrive
any time within the next two to thirty-two days. Since the total invoice is large
and since the dollar is likely to strengthen, CTN plc now wish to cover their
exposure.
Their first thought is to use a bank’s forward time option.
Given the following rates:
Spot GBP/USD
1.6390
-
1.6400
30 day points
97
______
-
95
______
1.6293
-
1.6305
i)
ii)
What would the bank’s two way quote be for a time option running from T2
to T32?
Is there a better way of covering the exposure?
Options
Some Terminology
*
European
-
Right to exercise only at maturity.
*
American
-
Right to exercise at any time in the option period.
*
Traded
-
Traded on an exchange. Will be a standard contract.
*
Over the counter or O.T.C.
*
Put
-
Buyer of a put has the option to give currency,
take dollars.
*
Call
-
Buyer has the option to take currency, give dollars.
*
In, At, Out of the money
-
Tailor made option.
Example: Sterling Call, Strike Price of 1.82
6
Value of
5
Option
4
Cents
3
2
Out of
At
In The Money
1
0 ------------------------------------------------178
*
180 181 182 183
Current Cash market
Intrinsic and Time Value
GBP Call at
Current Spot
Premium
*
179
1.8250
for September
1.8840
5.90 cents: Intrinsic Value
6.05
.15
Time Value
Effective rate equals Strike Price + or – the premium
Call = + i.e. 1.8250 + 6.05 cents = 1.8855
Put = - i.e. 1.8500 - 3.10 cents = 1.8190
184
185
Options
A.
Which cash price is the underlying?
You have a September GBP call with a strike price of 165.
Today is June 20th.
Current Spot is
3 Mo Fwd is
1.6930
1.6785
You have two alternatives. Exercise today or sell sterling forward. Question,
which action will give you most profit?
1.
2.
Exercise today
Give 1.6500
Get
1.6930
Net
430
Get
Give
GBP1.00
GBP1.00
Sell GBP forward. At expiry date exercise and
Give 1.6500
Get
GBP1.00
Get
1.6785
Give
GBP1.00 to cover forward sale
Net
285
So underlying is spot
Note: GBP is at a discount to USD call
= spot underlying
Therefore
put
= forward underlying
For currencies at a premium to the USD Vice Versa.
B.
Better to sell than to exercise.
Sept £ call
Today’s spot
=
SP165
1.6930
Sept call SP165 option, current premium 5.62 cents.
You could exercise. If you did each £ would cost 1.65
Or
You could sell the option
- sell option, receive
- transact £ deal in spot market to
cover expenditure at
Net $ outflow
If you exercise you only pick up the intrinsic value.
If you sell you pick up the intrinsic and time value.
+ .0562
- 1.6930
- 1.6368
Time Value
Options
28.2.95
Philadelphia SE £/$ Options £31250 (Cents per Pound)
Strike Price
Call
Underlying
March
Premium
Intrinsic
Value
Time
Value
1.500
1.525
1.550
1.575
1.600
1.625
1.5756
“
“
“
“
“
7.90
5.48
3.13
1.27
.31
.02
7.56
5.06
2.56
.06
-
.34
.42
.57
1.21
.31
.02
May
Premium
Intrinsic
Value
Time
Value
8.02
5.98
4.16
2.68
1.65
.93
7.56
5.06
2.56
.06
-
.46
.92
1.60
2.62
1.65
.93
Note. Time value is greatest when at the money.