OPTION CONTRACTS:

PARTIES:
Option Holder – option buyer (has the right to buy or sell)
Option Writer – option seller (grants the holder this contractual
right)

OPTION: IF Spot / Market Price > Exercise Strike / Option

Price
CALL – in the money (Holder will exercise the option)
PUT – out of the money (Holder will not exercise the option)
 If SMP = ESP – at the money whether call or put option

OPTION PREMIUMS: (at the inception of FC Option)

 Time Value – OPTION is AT / OUT of the money
 Intrinsic Value – OPTION is IN the money

ILLUSTRATIVE PROBLEM: On December 1, 2017, Hope

Company paid P3,000 to purchase a 90-day call option for
500,000 Thailand baht. The option’s purpose is to protect an
exposed liability of 500,000 baht relating to a purchase of
merchandise received on December 1, 2017 and to be paid on
March 1, 2018.

Relevant rates and market values at different dates are as follows:

12/01/2017 12/31/2017 03/01/2018

Spot rate (market price) P1.20 P1.28 P1.27
Strike price (exercise price) 1.20 1.20 1.20
Fair value of call option P3,000 P42,000 P35,000

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1. What is the Forex Contract value-option as of December 31,
2017?
12/01/2017 12/31/2017 03/01/2018
Spot rate (market price) P1.20 P1.28 P1.27
Strike price (exercise price) 1.20 1.20 1.20
*Spot > Strike = IN 0 0.08 0.07
the money. Otherwise it is AT the money IN the IN the money
AT the money money
IV = (Spot-Strike) X FCU Time Value Intrinsic Intrinsic
TV= FV option - IV value Value
Fair value of call option P3,000 P42,000 P35,000
Intrinsic Value 0 40,000 35,000
Time Value 3,000 2,000 0

At Fair Value Call Option = 42,000

2. What is the Net forex gain or (loss) as of December 31, 2017

Since it is IN the MONEY,The Call option or option to buy at strike
price will be exercised. Thus, the difference in the Change Fair Value
Call Option shall be recognized as FoRex Gain or (loss).

I. (Change in FAIR VALUE Call Option):

December 31, 2017 value - 42,000 new balance
December 1, 2017 value - (3,000) old balance
Increase in FV Call option= 39,000 net gain

OR
II.(Change in the Intrinsic Value Call Option):
[SPOT - STRIKE ] X FCU = Intrinsic Value
[ 1.28 - 1.20] x 500,000 = 40,000 (Dec 31 IV)

December 31, 2017 IV - 40,000 new balance

December 1, 2017 IV - (0) old balance (because AT the money)
Change in intrinsic value = 40,000 loss

III. Net FoRex Gain / (loss):

As of December 31, 2017: (New)

Fair Value call option = 42,000
(intrinsic value ) = (40,000) =(1.28-1.20)x500,000 [IN the money]
Time Value = 2,000

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 As of December 1, 2017: (Old)
Fair value call option = 3,000
(intrinsic value) = (0) = SMP=ESP, thus AT the money
Time Value = 3,000

Change in TV = 2,000 - 3,000 = (1,000) loss

December 31, 2017 TV -2,000 new balance

December 1, 2017 TV - (3,000) old balance (because AT the
money)
Change in time value = 1,000 Loss
OR
40,000 – 1,000 = 39,000 net Gain

3. Net forex gain or (loss) as of March 1, 2018 (expiration date)

Since it is IN the MONEY, the Call option or option to buy at strike

price will be exercised. Thus, the difference in the Change Fair Value
Call Option and the Change in the Intrinsic Value shall be recognized
as FoRex Gain or (loss).

I. (Change in FAIR VALUE Call Option):

March 1, 2018 value - 35,000 new balance
December 31, 2017 value - (42,000) old balance
Increase in FV Call option= (7,000) Net loss

OR
II.(Change in the Intrinsic Value Call Option):
[SPOT - STRIKE ] X FCU = Intrinsic Value
[ 1.27 - 1.20] x 500,000 = 35,000 (March 2018 IV)

March 1, 2018 IV - 35,000 new balance

December 31, 2017 IV - (40,000) old balance
Change in intrinsic value = (5,000) loss

III. Net FoRex Gain / (loss)

As of March 1, 2018: (New)

Fair Value call option = 35,000
(intrinsic value ) = (35,000) =(1.27-1.20)x500,000 [IN the money]

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 Time Value = 0

As of December 31, 2017: (Old)

Fair value call option = 42,000
(intrinsic value) =(40,0000) = SMP=ESP, thus AT the money
Time Value = 2,000

Change in TV = 0 - 2,000 = (2,000) loss

Net Forex (Loss):
5,000 loss plus 2,000 loss = (7,000) net Loss

4. Option’s time value at December 1, 2017?

Since spot rate is equal to exercise price, it is AT the money.
Thus, the Option's time value is at Fair value 3,000.

As of December 1, 2017: (Old)

Fair value call option = 3,000
(intrinsic value) = (0) = SMP=ESP, thus AT the money
Time Value = 3,000

5. Option’s intrinsic value at December 31, 2017

It is IN the Money. Thus, the Option's intrinsic value is
computed as follows:
[SPOT - STRIKE ] X FCU = IV
[ 1.28 - 1.20] x 500,000 = 40,000

6. Option’s time value at March 1, 2018

Zero (0) because the Sport rate is higher than Exercise price. Thus,
no time value but intrinsic value.

As of March 1, 2018: (New)

Fair Value call option = 35,000
(intrinsic value ) = (35,000) =(1.27-1.20)x500,000 [IN the money]
Time Value = 0

7. Option’s intrinsic value at March 1, 2018

It is IN the Money. Thus, the Option's intrinsic value is computed as
follows:
[SPOT - STRIKE ] X FCU = IV
[ 1.27 - 1.20] x 500,000 = 35,000

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