Call option exists on British pounds with an exercise price of $1.60, a 90-day expiration date, and a premium of $.03 per unit. A put option exists on British pounds with an exercise price of $1.60, a 90-day expiration date, and a premium of $.02 per unit. You plan to purchase options to cover your future receivables of 700,000 pounds in 90 days. You will exercise the option in 90 days (if at all). You expect the spot rate of the pound to be $1.57 in 90 days. Determine the amount of dollars to be received, after deducting payment for the option premium.

Solution:

The amount of dollars to be received, after the deduction of payment for the option premium is calculated as follows:

= ( Exercise price subtract Option premium ) multiply with the amount that is receivable

As per the given data,

Exercise price = $1.60, Option premium = 0.02, Amount which is receivable = 700000 pounds, expiration date = 90-days

Putting these figures in formula, we get,

= pounds = $1106000.

Therefore, the amount that will be received will be $1106000

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