28 Speculating with currency straddles. Maggie Hawthorne is a currency speculator. She has noticed that recently the dollar has depreciated substantially against the euro. The current exchange rate of the dollar is 0.78 euro. After reading a variety of articles on the subject, she believes that the dollar will continue to fluctuate substantially in the months to come.

Although most forecasters believe that the dollar will depreciate against the euro in the near future, Maggie thinks that there is also a good possibility of further appreciation. Currently, a call option on dollars is available with an exercise price of 0.80 euro and a premium of 0.04 euro. A euro put option with an exercise price of 0.80 euro and a premium of 0.03 euro is also available. (See Appendix 5B in this chapter.)

a Describe how Maggie could use straddles to speculate on the dollar’s value.

b At option expiration, the value of the dollar is 0.90 euro. What is Maggie’s total profit or loss from a long straddle position?

c What is Maggie’s total profit or loss from a long straddle position if the value of the dollar is 0.60 euro at option expiration?

d What is Maggie’s total profit or loss from a long straddle position if the value of the dollar at option expiration is still 0.78 euro?
e Given your answers to the questions above, when is it advantageous for a speculator to engage in a long straddle? When is it advantageous to engage in a short straddle?