For buying the right put option buyer will pay an amount to put option seller that is called premium.
The put option buyer will make profit if the price of the underlying asset will decrease.
If on or before the expiration date, price of the underlying currency move above the strike price, the maximum loss a put option buyer will bear would be the premium amount.
Payoff and Profit at The Expiry of Currency Put Option Contract
Put Option Buyer’s Perspective
The put option buyer will exercise his right only if he is in profit that means he will exercise his right only when market price is lower than strike price.
Put Option Buyer’s Payoff: – Strike Price – Market Price
Profit/Loss for Put Option Buyer: – Strike Price – Market Price – Premium
Put Option Seller’s Perspective
Put Option Seller’s Payoff: – [ – Strike Price – Market Price]
Profit/Loss for Put Option Seller: – [ – Strike Price -Market Price – Premium]
An Indian exporter will receive $10,00,000 within 60-days for exporting medicine to USA. Exporter anticipates that $ price in terms of Rupee may fall in future. Therefore, he decided to enter into currency put option contract. Following are the details –
Strike Price = ₹ 75
Premium = ₹ 2
Spot Price 1$ = ₹ 71.50 after 60 days
The exporter has bought a currency put option, therefore he has right to sell $ (Currency) at ₹ 75 (Strike Price). At the expiry of the contract spot price of the $ is ₹ 71.50.
As the exporter can sell the $ at a higher price as compare to market (spot price), he will exercise his right and, in this case, payoff would be₹ 35,00,000 [$10,00,000 * (75.00 – 71.50)].
Therefore, profit would be ₹ 15,00,000 [$10,00,000 * ((₹ 3.50 – ₹2 (premium))]. In this example you can see, how exporter hedged himself by currency put option and also earned profit of ₹ 15,00,000.