Currency Options

1

• Currency Options
• (Shapiro Chapter 8)

2
Options Contracts

• A contract from a writer ( the seller) that gives
  the right not the obligation to the holder (the
  buyer) to buy or sell a standard amount of an
  available currency at a fixed exchange rate for a
  fixed time period.
• Calls vs. Puts
• Call options gives the holder the right, but not
  the obligation, to buy a given quantity of some
  asset at some time in the future, at prices
  agreed upon today.
• Put options gives the holder the right, but not
  the obligation, to sell a given quantity of some
  asset at some time in the future, at prices
  agreed upon today.

3

• Currency options
• Offer another method to hedge exchange rate risk.
• Fastest growing segment of the hedge markets.
• Exchange traded currency options were first
  offered in 1983 by the Philadelphia Stock
  Exchange (PHLX) (www.phlx.com)
• They are now traded on the PHLX and the Chicago
  Mercantile Exchange (CME) (www.cme.com)
• Size of contracts
• Contracts on the CME are generally twice the size
  of the PHLX contracts (except for the pound where
  the PHLX contract is 25 larger than the CME
  contract)
• Generally contract size for options is half that
  for futures

4
(Exhibit continues on next slide)
5
(No Transcript)
6
European vs. American options

• European options can only be exercised on the
  expiration date.
• American options can be exercised at any time up
  to and including the expiration date.
• Since this option to exercise early generally has
  value, American options are usually worth more
  than European options, other things equal.

7
Option Description

• In-the-money (Profit)
• Call Spot Price (ST)gt exercise price
  (strike price)
• ST gt E (or X)
• Put Spot Price lt exercise price (strike
  price)
• At-the-money (Indifference)
• Spot Price exercise price (strike price)
• Out-of-the-money (Loss)
• Call Spot Price lt exercise price (strike price)
• Put Spot Price gt exercise price (strike
  price)

8
Buying a Call Option

• Example (Exhibit 8.4) Exercise price of Euro call
  option is 0.94 (E or X) per Euro. The option
  premium is 0.02 per Euro (or 1,250 per
  contract). The option has 60 days to expiration.
  The profit/loss on the position depends on the
  exchange rate.
• Exchange rate Exercise Profit/Loss
• 0.90 No -1,250
• 0.92 No -1,250
• 0.94 No -1,250
• 0.96 Yes 0 (Breakeven)
• 0.98 Yes 1,250
• 1.00 Yes 2,500
• Max ST -E, 0 Call Option
  Premium

9
(No Transcript)
10
Selling a Call Option

• Profit/Loss would be reversed if instead of
  buying a call option you sold (wrote) a call
  option
• Exchange rate Exercise Profit/Loss
• 0.90 No 1,250
• 0.92 No 1,250
• 0.94 No 1,250
• 0.96 Yes 0 (Breakeven)
• 0.98 Yes - 1,250
• 1.00 Yes -2,500
• - Max ST -E, 0 Call Option
  Premium

11
(No Transcript)
12
Buying a Put Option

• Example (Exhibit 8.6) Exercise price of Euro put
  option is 0.94 (E or X) per Euro. The option
  premium is 0.02 per Euro (or 1,250 per
  contract). The option has 60 days to expiration.
  The profit/loss on the position depends on the
  exchange rate.
• Exchange rate Exercise Profit/Loss
• 0.90 Yes 1,250
• 0.92 Yes 0 (Breakeven)
• 0.94 No -1,250
• 0.96 No -1,250
• 0.98 No -1,250
• 1.00 No -1,250
• Max E - ST, 0 Put Option
  Premium

13
(No Transcript)
14
Selling a Put Option

• Profit/Loss would be reversed if instead of
  buying a put option you sold (wrote) a put option
• Exchange rate Exercise Profit/Loss
• 0.90 Yes -1,250
• 0.92 Yes 0
• 0.94 No 1,250
• 0.96 No 1,250
• 0.98 No 1,250
• 1.00 No 1,250
• - Max E - ST, 0 Put Option Premium

15
(No Transcript)
16
Currency Spread

• It involves buying an option at one exercise
  price and selling a similar option at a different
  exercise price.
• Bull Spread
• -- Definition a spread designed to bet on
  a currencys
• appreciation.
• -- It would involve buying a call at one
  exercise price
• and selling another call at a higher
  exercise price
• Bear Spread
• -- Definition a spread designed to bet on
  a currencys
• decline.
• -- It would involve buying a put at one
  exercise price
• and selling another put at a higher
  exercise price

17
(Exhibit continues on next slide)
18
(No Transcript)