Currency Option Combinations

A currency option combination uses simultaneous call and put option positions to construct a unique position to suit the hedger's or speculator's needs. Of many combination options, we focus on few strategies. Long currency straddle involves buying (a long position) both a call option and a put option for a particular foreign currency with the same expiration date and strike price. The strategy allows the buyer both the right to buy the foreign currency and the right to sell the foreign currency.

Speculating with Long Currency Straddle

A long currency straddle involves buying both a call option and a put option for a particular foreign currency with the same expiration date and strike price. Suppose that a speculator predicts substantial volatility in the exchange rate of euro and so buys a long euro currency straddles with following terms and conditions:

Call premium on euro is $0.03 per unit.

Put premium on euro is $0.02 per unit.

Strike price is $1.05.

One option contract represents €62,500.

Required:

If the future spot rate of euro at option expiration is uncertain and takes a value within a range of $0.95 to $1.10, construct a contingency graph for a long currency straddle and below the graph show the related net profit or loss to the straddle buyer? Explain your findings and draw implications for speculators.

Critical view: When constructing a long straddle, the buyer purchases both the right to buy the foreign currency and the right to sell the foreign currency. The strategy becomes profitable when the foreign currency either depreciates or appreciates substantially. The disadvantage of a long straddle is that it is expensive to construct because it involves buying two options and the total premium payments would be loss if the exchange rate remain stable.