Frank is an option speculator. He anticipates the Danish kroner will appreciate from its current level of $.19 to $.21. Currently, kroner call options are available with an exercise price of $.18 and a premium of $.02. Should Frank attempt to buy this option? If the future spot rate of the Danish kroner is indeed $.21, what is his profit or loss per unit?

Question

Quizplus · Accepted Answer

If the future spot rate of the Danish kroner is indeed $.21, Frank's profit per unit will be $0.01. This is because he will be able to exercise his option to buy kroner at $.18 and then immediately sell them in the spot market for $.21, netting a profit of $.03 per unit. However, he will have to pay a premium of $.02 to buy the option, so his overall profit will be $0.01 per unit.

Frank Is an Option Speculator