Call Option

By Shrikanth Naik
Example
You are importing goods worth $100,000 from American. Money
payable in $ after 90 days. Todays exchange rate is Rs. 60/$. You expect
$ to appreciate to Rs. 63/$.
You enter in to call option deal with banker on following terms
Premium Rs. 1/$
Strike price Rs. 61/$
If the market price after 90 days is a) Rs.59 b) Rs.64 c) Rs. 61
Explain your decision in
1. In the money 2. out of money 3. at the money
Solution
Calculation of Option Price/ Cost of Option:
Strike price 61*$100,000 = Rs 61,00,000
Add premium 1*$1,00,000 = Rs 1,00,000
Price of option Rs 62,00,000
Option price = 62,00,000 = Rs 62.
1,00,000
Case 1: if market price Rs.59/$
importer has to pay
market price is Rs 59*100,000 = 59,00,000
Add premium Rs.1*100,000 = 100,000
total price = 60,00,000
Market price = total price = 60,00,000 =Rs.60/$
units of $ 100,000
Option price is Rs.62 and open market price is Rs.60
Importer will cancel the options to buy from banker is costly. i,.e Rs.62
But will buy from open market price Rs.60 and will save (62-60) Rs.2.
In this case, strike rate is higher than spot rate(market price). So it is
called out of money.
Case 2 : If market price is Rs.64/$
Importer has to pay
Market price is Rs. 64*100,000$ = 64,00,000
Add premium Rs. 1 *100,000$ = 100,000
total price = 65,00,000
Market price = 65,00,000 = Rs.65/$
100,000
Importer will loss (65-62) Rs.3. hence importer will select bank option Rs.62.
so it is called in the money. In this case, strike rate is less than spot
rate(market price).
Case 3: if market price is Rs. 61/$
Importer has to pay
Strike price Rs. 61* 100,000 = 61,00,000
add premium 1*100,000 = 100,000
= 62,00,000
Market price = 62,00,000 = Rs.62/$
100,000
In this case there is no loss or gain. He may select both option it is called at
the money. In this case, strike rate is equal spot rate(market price).