On February 21st, 2017, your friend placed the following order on an online trading provider:
Short 10 European call currency option contracts on Australian dollars with maturity August 2017 and strike 0.8000
Short 20 European put currency options contracts on Australian dollars with maturity August 2017 and strike 0.7500. Each contract has a size of 10,000 Australian dollars.
On February 21st, 2017, the spot exchange rate was quoted at 0.7715 USD per Australian dollar, the US interest rate was 2.02% p.a. and the Australian interest rate was 2.88% p.a. with continuous compounding. The exchange rate volatility was 23% p.a..
a) Use the Black Scholes’s model to estimate the premium involved to trade these options. Did he pay or receive this premium?
b) Indentify the strategy that your friend used and provide the table and the diagram of the expected profit/loss generated by the strategy.
c) Discuss the profit and loss potential associated with this strategy. What was your friend’s expectation on market volatility and direction (bull or bear) when he placed the order?
d) Calculate the losses your friend would be making if he exercises in August 2017 when the spot exchange rate is 0.9250.