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Long/ Short position in a put/ short option with an exercise price

Suppose that Janice, a Hong Kong investor, holds one euro, currently valued at 15 (the exchange rate of the Hong Kong dollar against the euro in direct quote). She is concerned that over the next few months the value of her holding might decline and she would like to hedge that risk by supplementing her holding with one of the following two option positions, all of which expire at the same point in the future. Complete a table similar to the following for each of the following positions.

(Please see the table in the attached file)

In calculating the combined terminal position value, ignore the time differential between the initial option expense or receipt and the terminal payoff.

(a) a long position in a put option with an exercise price of 13 and a premium of $1 (6marks)

(b) a short position in a call option with an exercise price of 13 and a premium of $2 (6marks)

(c) a long position in a call position with an exercise price of 13 and a premium of 2 and a long position in a put option with an exercise price of 13 and a premium of $1 (i.e. a long position in a straddle). (8marks)

(d) Graph the combined terminal position value for each of above, using combined terminal position value on the vertical axis and the euro's expiration date exchange rate on the horizontal axis (9marks)

(e) Does it make sense to hedge the risk using a long position in a straddle? Explain. (5marks)

(f) Under what circumstance could the risk be hedged by a long position in a call written on US dollars? Explain. (5marks)

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Solution Summary

Long and short position in a put/short option with exercise prices are examined.

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