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Currency Options Market

The document discusses different types of currency options, including calls and puts traded on exchanges and in over-the-counter markets. Currency call options grant the holder the right to buy a currency at a set price, while put options grant the right to sell. These options can be used by firms to hedge currency risk and by speculators expecting currency movements. Premiums and profits depend on the relationship between the spot and strike prices over the life of the option.

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Tajrian Ahmmed 1512588630
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39 views

Currency Options Market

The document discusses different types of currency options, including calls and puts traded on exchanges and in over-the-counter markets. Currency call options grant the holder the right to buy a currency at a set price, while put options grant the right to sell. These options can be used by firms to hedge currency risk and by speculators expecting currency movements. Premiums and profits depend on the relationship between the spot and strike prices over the life of the option.

Uploaded by

Tajrian Ahmmed 1512588630
Copyright
© © All Rights Reserved
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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• A currency option is another type of contract that can be

purchased or sold by speculators and firms.


• The standard options that are traded on an exchange through
brokers are guaranteed, but require margin maintenance.
• U.S. option exchanges (e.g. Chicago Board of Options
Exchange) are regulated by the Securities and Exchange
Commission.

Currency Options
Market
Currency Options
Market
• In addition to the exchanges, there is an over-the-counter
market where commercial banks and brokerage firms offer
customized currency options.
• There are no credit guarantees for these OTC options, so some
form of collateral may be required.
• Currency options are classified as either calls or puts.
Currency Call
Options
• A currency call option grants the holder the right to buy a
specific currency at a specific price (called the exercise or
strike price) within a specific period of time.
• A call option is
o in the money if spot rate > strike price,
o at the money if spot rate = strike price,
o out of the money
if spot rate < strike price.
Currency Call
Options
• Option owners can sell or exercise their options. They can also
choose to let their options expire. At most, they will lose the
premiums they paid for their options.
• Call option premiums will be higher when:
o (spot price – strike price) is larger;
o the time to expiration date is longer; and
o the variability of the currency is greater.
Currency Call
Options
• Firms with open positions in foreign currencies may use
currency call options to cover those positions.
• They may purchase currency call options
o to hedge future payables;
o to hedge potential expenses when bidding on projects; and
o to hedge potential costs when attempting to acquire other firms.
Currency Call
Options
• Speculators who expect a foreign currency to appreciate can
purchase call options on that currency.
o Profit = selling price – buying (strike) price – option premium
• They may also sell (write) call options on a currency that they
expect to depreciate.
o Profit = option premium – buying price + selling (strike) price
Currency Call
Options
• The purchaser of a call option will break even when
selling price = buying (strike) price
+ option premium
• The seller (writer) of a call option will break even when
buying price = selling (strike) price
+ option premium
Currency Put
Options
• A currency put option grants the holder the right to sell a
specific currency at a specific price (the strike price) within a
specific period of time.
• A put option is
o in the money if spot rate < strike price,
o at the money if spot rate = strike price,
o out of the money
if spot rate > strike price.
Currency Put
Options
• Put option premiums will be higher when:
o (strike price – spot rate) is larger;
o the time to expiration date is longer; and
o the variability of the currency is greater.

• Corporations with open foreign currency positions may use


currency put options to cover their positions.
o For example, firms may purchase put options to hedge future receivables.
Currency Put
Options
• Speculators who expect a foreign currency to depreciate can
purchase put options on that currency.
o Profit = selling (strike) price – buying price – option premium
• They may also sell (write) put options on a currency that they
expect to appreciate.
o Profit = option premium + selling price – buying (strike) price
Currency Put
Options
• One possible speculative strategy for volatile currencies is to
purchase both a put option and a call option at the same
exercise price. This is called a straddle.
• By purchasing both options, the speculator may gain if the
currency moves substantially in either direction, or if it moves
in one direction followed by the other.
Contingency Graphs for Currency Options
For Buyer of £ Call Option For Seller of £ Call Option
Strike price = $1.50 Strike price = $1.50
Premium = $ .02 Premium = $ .02
Net Profit Net Profit
per Unit per Unit
+$.04 +$.04
Future
+$.02 +$.02 Spot
Rate
0 0
$1.46 $1.50 $1.54 $1.46 $1.50 $1.54
- $.02 Future - $.02
Spot
- $.04 Rate - $.04
Contingency Graphs for Currency Options
For Buyer of £ Put Option For Seller of £ Put Option
Strike price = $1.50 Strike price = $1.50
Premium = $ .03 Premium = $ .03
Net Profit Net Profit
per Unit per Unit
+$.04 +$.04
Future
+$.02 Spot +$.02
Rate
0 0
$1.46 $1.50 $1.54 $1.46 $1.50 $1.54
- $.02 - $.02 Future
Spot
- $.04 - $.04 Rate
European Currency
Options
• European-style currency options are similar to American-style
options except that they can only be exercised on the
expiration date.
• For firms that purchase options to hedge future cash flows,
this loss in terms of flexibility is probably not an issue. Hence,
if their premiums are lower, European-style currency options
may be preferred.
Efficiency of
Currency Futures and
Options
• If foreign exchange markets are efficient, speculation in the
currency futures and options markets should not consistently
generate abnormally large profits.
• A speculative strategy requires the speculator to incur risk. On
the other hand, corporations use the futures and options
markets to reduce their exposure to fluctuating exchange rates.
Impact of Currency DerivativesCurrency
on an MNC’s
Futures Value
Currency Options

m 
n 

E  CFj , t   E ER j , t   
 j 1 
Value =   
t =1  1  k  t

 
E (CFj,t ) = expected cash flows in
currency j to be received by the U.S. parent at
the end of period t
E (ERj,t ) = expected exchange rate at
which currency j can be converted to dollars at
the end of period t
k = weighted average cost of capital of
the parent
Option Matrix

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