The current ¥/$ spot rate is 123.00. 6 month European calls with strike 0.0087 and 0.0083 ($/¥) are trading at premia of ¢ 0.015/¥ and ¢ 0.02/$ (cents per yen) respectively. A speculator is expecting a fairly strong appreciation of the yen over the next six months. What option strategy should he adopt to profit from this forecast? What is the breakeven rate? How much is the maximum possible profit? Ignore brokerage fees and interest costs/gains.
Solution
A limited risk speculative strategy would be the bullish call spread i.e. buy the call with strike $0.0083 or 0.83 cents per yen and sell the call with strike $0.0087 or 0.87cent per yen.
The initial investment would be (0.02-0.015) = 0.005 cent per yen. The breakeven spot rate would be 0.83+0.005 = 0.8350 cent per yen.
Maximum profit potential would be (0.87-0.83)– (0.02-0.015) = 0.035 cent per yen.
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