Speculating with Currency Straddles Maggie Hawthorne is a currency speculator. She has noticed that recently the euro has appreciated substantially against the U.S. dollar. The current exchange rate of the euro is $1.15. After reading a variety of articles on the subject, Maggie believes that the euro will continue to fluctuate substantially in the months to come. Although most forecasters expect that the euro will depreciate against the dollar in the near future, Maggie thinks that there is also a good possibility of further appreciation. Currently, a call option on euros is available with an exercise price of $1.17 and a premium of $0.04. A euro put option with an exercise price of $1.17 and a premium of $0.03 is also available. (See Appendix B in this chapter.) Describe how Maggie could use straddles to speculate on the euro’s value. At option expiration, the value of the euro is $1.30. What is Maggie’s total profit or loss from a long straddle position? What is Maggie’s total profit or loss from a long straddle position if the value of the euro is $1.05 at option expiration? What is Maggie’s total profit or loss from a long straddle position if the value of the euro at option expiration is still $1.15? Given your answers to parts (b) through (d), when is it advantageous for a speculator to engage in a long straddle? When is it advantageous to engage in a short straddle?

FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698
FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698

Solutions

Chapter 5, Problem 30QA
Textbook Problem

Speculating with Currency Straddles Maggie Hawthorne is a currency speculator. She has noticed that recently the euro has appreciated substantially against the U.S. dollar. The current exchange rate of the euro is $1.15. After reading a variety of articles on the subject, Maggie believes that the euro will continue to fluctuate substantially in the months to come. Although most forecasters expect that the euro will depreciate against the dollar in the near future, Maggie thinks that there is also a good possibility of further appreciation. Currently, a call option on euros is available with an exercise price of $1.17 and a premium of $0.04. A euro put option with an exercise price of $1.17 and a premium of $0.03 is also available. (See Appendix B in this chapter.)

  1. Describe how Maggie could use straddles to speculate on the euro’s value.
  2. At option expiration, the value of the euro is $1.30. What is Maggie’s total profit or loss from a long straddle position?
  3. What is Maggie’s total profit or loss from a long straddle position if the value of the euro is $1.05 at option expiration?
  4. What is Maggie’s total profit or loss from a long straddle position if the value of the euro at option expiration is still $1.15?
  5. Given your answers to parts (b) through (d), when is it advantageous for a speculator to engage in a long straddle? When is it advantageous to engage in a short straddle?

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