Problem:
A company finance director is expecting to receive US$2.1 million in export earnings in 90 days time. At that time she will need to purchase sterling. The spot rate is currently $1.35/£ but she anticipates that it may rise significantly before the earings arrive. She believes that the best hedging opportunity is offered by a foreign currency option and discovers the following quotes for 90-day option on the Chicago exchange:
Option strike price premium
Put on sterling $1.40 $0.0810/£
Call on sterling $1.40 $0.0276/£
The contract size is £62500
a) Using these quotes describe a suitable hedging strategy. Briefly explain your answer.
b) How many contracts would you advise the finance director to buy or sell and what is the break-even price ?
c) If the spot rate at expiration is $1.45, what are the company’s net sterling receipts from the transaction?