Hi everyone! I am wondering if anyone can kindly explain Q3 of example 6 re long seagull spread in the CFA 3 curriculum? Specifically, I am stuck in the part of “unlimited upside potential”. I thought if GBP keeps depreciating it works to our advantage, since we are converting ZAR to GBP. Why do we need to instead purchase an OTM put to gain the upside potential?
You don’t buy an OTM put for upside potential; you buy it for downside protection. You buy an OTM call for upside potential.
Hi thank you for your reply. I do understand that in general your statement stands, but in this question, since we are buying GBP and selling ZAR, the downside would be that GBP appreciates, hence we will need a call for downside protection (the exact reverse of the general rule). However, I am not able to figure out why buying a put can provide us with unlimited upside potential, as the correct answer A seems to suggest. Could you please maybe take another look at it? Thanks a lot.
Sorry: reading too late at night. I glossed over how they were quoting the exchange rates.
Note that the options are on ZAR/GBP, not on GBP/ZAR. A long call on GBP/ZAR gives unlimited upside, and a long call on GBP/ZAR is a long put on ZAR/GBP.