Assume that a speculator purchases a put option on British pounds (with a strike price of $1.50) for $.05 per unit. A pound option represents 31,250 units. Assume that at the time of the purchase, the spot rate of the pound is $1.51 and continually rises to $1.62 by the expiration date. The highest net profit possible for the speculator based on the information above is:
A) $1,562.50.
B) -$1,562.50.
C) -$1,250.00.
D) -$625.00.

Question

​Assume that a speculator purchases a put option on British pounds (with a strike price of $1.50) for $.05 per unit. A pound option represents 31,250 units. Assume that at the time of the purchase, the spot rate of the pound is $1.51 and continually rises to $1.62 by the expiration date. The highest net profit possible for the speculator based on the information above is:
A) ​$1,562.50.
B) ​-$1,562.50.
C) ​-$1,250.00.
D) ​-$625.00.

Quizplus · Accepted Answer

The speculator has purchased a put option, which gives the right to sell British pounds at a strike price of $1.50. As the spot rate of the pound continually rises to $1.62 by the expiration date, the option becomes more and more valuable.

The maximum profit for the speculator is achieved when the spot rate of the pound is below the strike price of $1.50. In this case, the speculator can exercise the put option and sell pounds at $1.50, even though the market rate is higher.

The net profit for the speculator is calculated as follows:

Net profit = (Strike price - Spot rate at expiration) x Number of units x Option price
Net profit = ($1.50 - $1.62) x 31,250 x $0.05
Net profit = -$0.12 x 31,250 x $0.05
Net profit = -$156.25

However, the speculator has only paid a premium of $0.05 per unit, or $1,562.50 for the entire option. Therefore, the maximum net profit for the speculator is:

Maximum net profit = Premium - Net loss
Maximum net profit = $1,562.50 - (-$156.25)
Maximum net profit = $1,718.75

Therefore, the best choice is B.

​Assume That a Speculator Purchases a Put Option on British

Assume That a Speculator Purchases a Put Option on British