Assume that today is June 11. Your firm is scheduled to pay £500,000 on August 15, 65 days in the future. The current spot is $1.75/£, and the 65-day forward rate is $1.73/£. You can borrow and lend dollars at 7% p.a. Suppose you think options are overpriced because you think the dollar will be in a tight trading range in the near future. You have been thinking about selling an option as a way to reduce the dollar cost of your pound payable.

a. If an August pound option with a strike price of 175¢/£ costs 4.5¢/£ per pound for the call and 4¢/£ for the put, what is the minimum effective exchange rate in August that you will pay? Over what range of future exchange rates will this price be achieved?

b. How much must the pound appreciate before your speculative option strategy ends up costing you more than the forward rate?