Currency Options Flashcards
Major organized exchange
LIFFE- london
CME- chicago
PHLX- philadelphia
AEX- amsterdam
MX- montreal
What is an option contract
A contract that gives the purchaser the right but not the obligation to buy or sell a given amount of foreign exchange at a fixed prices per unit for a specified time period
The buyer pays the premium for the right to buy or sell the currency
What are the risk fir the buy and the seller of the option
-the buyer cannot lose more than the premium, the buyer is taking a ling position
The seller might incur infinite loss. The seller is said to take a short position
Types of options
Call option: is an option to buy foreign currency
Put option: is an option to sell foreign currency
European option: can be exercised only on the expiration date
American option: can be exercised any time before the expiration date
Types of position of an option to the spot rate
If The option is profitable to exercise, the option is in the money
If the option is not profitable to exercise the option is out of the money
If spit price coincide with the exercise price of the quotation the option is at the money
How do we calculate the value of an option
Intrinsic value: the amount by which the option is in the money, that us equivalent to the immediate exercise value of the option
Time value: an excess of the option value over its intrinsic value, it exists because the price of the underlying currency has a potential to move further from the strike price between present time and the option expiration date
Forward and futures vs options
Forward and futures offer a protection against exchange rate risk exposure at the lowest cost
Options offer a protection at a premium
Forwards and futures eliminate any upside impact of the exchange rate risk
Options do not eliminate the upside impact of the exchange rate risk
What is the best hedging strategy
There is no best hedging strategy
The choice of hedge depends on:
-company’s expectation about future exchange rate changes
-amount of foreign currency needed to be hedged
-availability of funds for paying the option premium
-hedging habit
The premium is sensitive to changes in?
Spot rates
Forward rates
Maturity
Volatility of exchange rates
Alternative option prices
Interest rate differential
