Money, Banking, and International Financemarket to earn a large profit. For example, if the spot price for petroleum is $90 per barrel, we
computed the company could earn $990,000 in profits in Equation 5:
ݐ݂݅ݎ=(ݐݏ ݁ܿ݅ݎ−݁݇݅ݎݐݏ ݁ܿ݅ݎ)∙ݕݐ݅ݐ݊ܽݑݍ−݉ݑ݅݉݁ݎ (5)
ݐ݂݅ݎ=($90−$80)∙ 100 , 000 −$10, 000 =$990,000Scenario 2: If spot market price falls below $80 per barrel, subsequently, the company does
not exercise the option. However, the company has paid the $10,000 premium.
Example 2: Strike price for a European put option is $40 per ton of corn, and the premium
equals $0.07 per ton. Each option contract specifies a quantity of 10,000 tons. A farmer buys
five put options, insuring 50,000 tons of corn. Consequently, the farmer pays $0.07 × 10,000 × 5
= $3,500 in premiums.
A farmer will experience two scenarios:
Scenario 1: If the spot market price exceeds the $40 strike price, then the farmer does not
exercise put option because he or she could sell corn for a greater price on the spot market.
Nevertheless, the farmer has paid the option premium of $3,500.
Scenario 2: If spot market price falls below the $40 per ton strike price, subsequently, the
farmer exercises the put option. Accordingly, the farmer could buy corn from the spot market
and sell to the holder of the put option. For example, the spot corn price is $25 per ton.
Consequently, we calculate the farmer earns $746,500 in profit in Equation 6.
ݐ݂݅ݎ=(݁݇݅ݎݐݏ ݁ܿ݅ݎ−ݐݏ ݁ܿ݅ݎ)∙ݕݐ݅ݐ݊ܽݑݍ−݉ݑ݅݉݁ݎ (6)
ݐ݂݅ݎ=($40−$25)∙ 50 , 000 −$3, 500 =$746,500Currency options are similar to commodity options, but the strike price is an exchange rate.
Furthermore, Currency options have two markets. First, Interbank (OTC) market is located in
London, New York, and Tokyo, and the OTC options are tailor-made for size, maturity, and
exercise price. Second, Philadelphia, United States has a market for currency options with fixed
maturities at 1, 3, 6, and 12 months.
Although currency options are more complicated to understand, the trick is to calculate both
scenarios: exercise or not exercise the option. Then choose the scenario that yields the greater
benefit to the option holder.
Example 3: An investor buys a six million ringgit European call option, and he or she has
U.S. dollars. Call option has a strike price of $0.3 US / ringgit. Did you notice the ringgit is in
the denominator of the strike price? Thus, we know this option is for ringgits. Premium equals
$0.01 per ringgit, and the contract size is 100,000 ringgits. Investor needs 60 contracts and pays
$60,000 for the premium, calculated in Equation 7.
6 60000
0.01
millionringgits=$ ,
ringgit$
premium ^ (7)^Investor faces two scenarios on the expiration date: