2009 AM Exam number 9 Put option

What is that calculation of value in this answer? Can anyone enlighten me? I though the Value (credit risk) to the long of a put was either

lets say the put is strike 100 and the spot at expiration is 98 - $2 per contract time notional of 12,500,000 = 24,000,000

or its the value of the premium for an out of the money.

This problem has some kind of value calculation for an out of the money put…WTH?

By the way, my answer to this was that there is no current credit risk becasue its european…guess i was wrong…

Maple Leaf is long a European put option, and thus it has the right to sell JPY at JPY 100 per CAD in six months. All of the credit risk associated with a currency option is borne by the long side of the option contract, i.e., Maple Leaf. This is because the long party seeks a payoff from the writer of the option should the option finish in-the-money. Because this is an OTC European option, with no payments required until expiration, Maple Leaf does not face any current risk until then. It does, however, face potential credit (counterparty) risk. If exchange rates remain unchanged until then, the risk to Maple Leaf can be calculated as: 1 1 0.000244 12,500,000 100 305000 100 102.5 − = × JPY × contracts = CAD On a per contract basis, Maple Leaf would expect a payoff of CAD 3,050 (or CAD 3,048.78 exactly). For an exchange-traded option prior to expiration, the current market value of the put option would be the amount at risk.

you have a CAD investor with a Put on JPY/CAD Currency.

When the rate increases from 100 -> 102 JPY/CAD

from a CAD perspective - things changed from 0.01 CAD/JPY to 0.0098

With a Strike of 0.01 -> the 0.0098 CAD/JPY became ITM.

So you also need to look at the Currency and Investor perspective.

He has a Put on JPY Notional as well.

yeah I just caught that probably as you were posting…


why then do we say here, there is POTENTIAL CREDIT RISK calculated as S-X?

I thought we said that for a european option, potential credit risk, is the price of the option?

However this example the put is OTC, not exchange traded.