Currency Bull Spread and Bear Spread:

A currency bull spread is constructed by buying a call option for a particular underlying currency and simultaneously writing a call option for the same currency with a higher strike price. Suppose that a spreader buys a call option on Australian dollars with a strike price $0.64 and a call premium of $0.019 and writes a call option on the same Australian dollars but with a strike price of $0.65 and a premium of $0.015. An option contract on Australian dollars consists of 50,000 units.

Required:

(a) Calculate the net profit (loss) for the bull spreader if the Australian dollar appreciates to $0.645 at the option expiration.

(b) Calculate the net profit (loss) for the bull spreader if the Australian dollar appreciates to $0.70 at the option expiration. Do you think a further appreciation of A$ would lead a higher profit for the spreader?

(c) Draw a contingency graph for the currency bull spread assuming that possible exchange rate will be any of the following: $0.60, $0.64, $0.645, $0.65, and $0.70.

(d) Repeat (c) assuming that the spreader writes the $0.64 option and buys the $0.65 option. Note that it is the case of currency bear spread.

Note: A currency bull spread can be constructed by a combination of put options too. To construct a put bull spread, the spreader would buy a put option with a lower strike price and write a put option with a higher strike price.