Journal Questions

For each of the following scenarios, prepare journal entries, general ledger, trial balance, income statement, and balance sheet.

Long Put, Nonhedging—Functional Currency US$

Cloud Fund had the following trades in Sun in the options market through David Brother brokers. The stock exchange requires that the writer of the options maintain 10 percent of the value of the contract as margin money throughout the life of the contract. On January 1, Cloud Fund introduced $100,000 as capital. We will prepare
Date            Product        StrikePrice         Expiry          Quantity    Rate       B/S         Brokerage
20-Jan-X1      Put               $50             16-Mar-X1      12,000    $5.00        B             $450
24-Feb-X1     Put               $50             16-Mar-X1      14,000    $4.00        B             $600
12-Mar-X1     Put               $50             16-Mar-X1      15,000    $4.00        S             $400

Liquidation Method
  FIFO

Market Rate of Underlying Stock, Sun
  January 31: 48.00
  February 28: 43.00
  March 16: $55

Market Rate of Sun Put Option with Strike Price $50, expiry March 16
  January 31: 2
  February 28: 6.00

Long Put, Nonhedging—Trade Currency SGD

Cerebros Fund had the following trades in ABB in the options market through James Brothers brokers. The stock exchange requires that the writer of the options maintain 10 percent of the value of the contract as margin money throughout the life of the contract. On January 1, Cerebros introduced $125,000 as capital.
Date            Product        StrikePrice        Expiry         Quantity   Rate (SGD)   B/S   Brokerage (SGD)
20-Jan-X1    Put               SGD 50         17-Mar-X1     15,000      9.00            B           600
22-Feb-X1   Put               SGD 50         17-Mar-X1     12,000      5.00            B            520
12-Mar-X1   Put               SGD 50         17-Mar-X1     14,000      6.00            S            700

Liquidation Method
  FIFO

Market Rate of Underlying Stock, ABB
  January 31: 48.00
  February 28: 44.00
  March 16: $55

Market Rate of ABB Put Option with Strike Price $50, Expiry March 17
  January 31: 3
  February 28: 5.00

FX Rate SGD/US$
  January 20: 1.5210
  January 31: 1.532
  February 22: 1.4956
  February 28: 1.500
  March 12: 1.5148
  March 17: 1.5463

Short Put, Nonhedging—Trade Currency INR

ABC Fund had the following trades in Andhra Bank in the options market through Silver Man brokers. The stock exchange requires that the writer of the options maintain 10 percent of the value of the contract as margin money throughout the life of the contract. On January 3, ABC Fund introduced $200,000 as capital and converted $100,000 into INR at 42.5 on the same date.
Date          Product      StrikePrice     Expiry         Quantity      Rate (INR)     B/S     Brokerage (INR)
23-Jan-X1   Put            INR 50      16-Mar-X1      10,000        5.00              S           540
23-Feb-X1  Put            INR 50      16-Mar-X1      16,000        4.00              S           620
10-Mar-X1  Put            INR 50      16-Mar-X1      16,000        3.00             B            320

Liquidation Method
  FIFO

Market Rate of Underlying Stock, Andhra Bank
  January 31: 49.00
  February 28: 44.00
  March 16: $55

Market Rate of Andhra Bank Put Option with Strike Price $50, Expiry March 16
  January 31: 2
  February 28: 6.00

FX Rate INR/US$
  January 23: 42.56
  January 31: 43.56
  February 23: 42.86
  February 28: 44.00
  March 10: 41.56
  March 16:42.00

Short Put, Nonhedging—Trade Currency SGD

Billionaire Fund had the following trades in SingTel shares in the options market through ASC Man brokers. The stock exchange requires that the writer of the options maintain 10 percent of the value of the contract as margin money throughout the life of the contract. On September 23 Billio-naire Fund introduced $200,000 as capital.
Date            Product        StrikePrice          Expiry       Quantity      Rate (SGD)    B/S    Brokerage
23-Sep-X1    Put               SGD 50         16-Nov-X1   10,000          5.00             S         540
23-Oct-X1    Put               SGD 50         16-Nov-X1     8,000          4.00             S         440
10-Nov-X1   Put               SGD 50         16-Nov-X1   12,000           3.00            B          720

Liquidation Method
  FIFO

Market Rate of Underlying SingTel:
  September 30: S$48.00
  October 31: S$43.00
  November 16: S$55

Market Rate of SingTel Put Option with Strike Price S$50, Expiry March 16
  September 30: S$2
  October 31: S$6.00

FX Rate SGD/US$
  September 23: 1.5210
  September 30: 1.532
  October 23: 1.4956
  October 31: 1.500
  November 10: 1.5148
  October 16:1.5463

Objective Questions

1. If the put option is purchased for speculative trade, then the premium paid towards purchase is treated as
a. Income.
b. Expense.
c. Gain.
d. None of the above.

2. For put options, the premium received towards sale is treated as
a. Income.
b. Expense.
c. Gain.
d. None of the above.

3. If a put option is purchased purely as a speculative trade, then the premium paid towards purchase of the put option is
a. Treated as revenue.
b. Treated as margin.
c. Treated as an asset.
d. Treated as an expense.
e. Treated as part of the cost.

4. For exchange-traded options, since the stock exchange has the responsibility of ensuring that both the legs of the transaction are complete, the exchange would insist that the writer of the option
a. Deposit the total value of the contract amount as collateral.
b. Pay a percentage value of the contract amount as premium.
c. Deposit a percentage value of the contract amount as margin.
d. Pay a percentage value of the brokerage amount as premium.
e. Receive the margin amount from the counterparty.

5. Assuming an investor writes a put option, he need not pay the brokerage because he is actually selling an option. Which of the following statements justifies that the above context is true or false?
a. True — since the investor receives a premium amount, he should receive the brokerage.
b. False — the investor has to pay the commission to the exchange.
c. True — because there are no brokers in between, no brokerage has to be paid.
d. False — since the trade is exercised through a broker, the investor has to pay the commission.
e. None of the above.

• The accounting treatment of put options prima facie will depend upon the intention with which the put options are purchased for hedging or speculation (nonhedging).
• If the position is taken as a hedge against some other position, then the relevant accounting standards for hedge accounting will be applicable, and there are certain conditions that are to be fulfilled for the same.
• If the put option is purchased purely as a speculative trade, then the premium paid towards purchase of the put option is taken to the expense and the premium received on sale of the options is treated as revenue.
• However, the value of the option is written back on the valuation date and shown as an asset in the case of purchase of put options. In effect, the net result of this method of accounting and the one shown earlier for hedging activity would be the same