ChatGPT
chatgpt.com/c/670f3b1b-5630-8009-905c-90173cfac0a2
Let's solve each part of the question:
Part a: Construct the contingency graph of a long currency straddle.
A long straddle involves buying both a call option and a put option for the same
underlying asset, strike price, and expiration date. Here's how the payoff works:
Call Option Premium: $0.03
Put Option Premium: $0.04
Strike Price: $1.15
Total Cost of the Straddle: $0.03 (call premium) + $0.04 (put premium) = $0.07
per unit
Payoff Calculation:
1. When the exchange rate is below the strike price ($1.15):
The call option will expire worthless.
The put option will be in-the-money, with a payoff of 1.15−ST, where STis the
spot rate at expiration.
The net payoff will be (1.15−ST)−0.07.
2. When the exchange rate is above the strike price ($1.15):
The put option will expire worthless.
The call option will be in-the-money, with a payoff of ST−1.15.
The net payoff will be (ST−1.15)−0.07.
3. At the strike price ($1.15):
Both options will expire worthless.
The total loss is the combined premium of $0.07.
I will plot the payoff graph for this straddle strategy.
Part b: Difference between direct and indirect quotation.
Direct Quotation: It represents the home currency price of one unit of a foreign
currency. For example, in the U.S., a direct quote for the Euro would be $1.15 per
Euro.
Indirect Quotation: It represents the foreign currency price of one unit of the home
currency. Using the same example, an indirect quote for the Euro in the U.S. would
be approximately 0.87 Euros per U.S. dollar.
Now, I'll plot the payoff graph for the long straddle strategy.
1/2
The payoff diagram above illustrates the net payoff for a long straddle strategy. Here’s
what it shows:
Loss at the strike price ($1.15): The maximum loss occurs when the spot price at
expiration is exactly the strike price, resulting in a loss of $0.07 (the total premium
paid for the call and put options).
Profitable scenarios: The straddle becomes profitable if the spot price at
expiration moves significantly away from $1.15 in either direction:
Above $1.22: The call option's profit will exceed the total premium paid.
Below $1.08: The put option's profit will exceed the total premium paid.
The straddle strategy profits from high volatility, regardless of the direction of the
currency's movement.
Part b: Difference between direct and indirect quotation (explained earlier)
Direct Quotation: Home currency price for one unit of foreign currency (e.g., USD
per Euro).
Indirect Quotation: Foreign currency price for one unit of home currency (e.g.,
Euro per USD).
2/2
