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I. OPTIONS A. Currency options 1. offer another product to hedge exchange rate risk. 2. first offered on Philadelphia Exchange (PHLX).
4. Definition: a contract from a writer ( the seller) that gives a. the right not the obligation to the holder (the buyer) to buy or sell b. a standard amount of an available currency at c. a fixed exchange rate for a fixed time period.
5. Two Types: Expiration Dates of Currency Options a. American exercise date may occur any time up to the expiration date. b. European exercise date occurs only at the expiration date and not before.
7. Exercise Price (exchange rate)
a. B. Sometimes known as the strike price. The exchange rate at which the option holder can buy or sell the contracted currency.
c. Types of Currency Options (whether you can buy or sell):
8. Status of an option a. In-the-money
Call: Spot > strike Put: Spot < strike
Call: Spot < strike Put: Spot > strike Spot = the strike
9. What is the premium: the price of an option that the writer charges the buyer.
B. Why Use Currency Options? 1. For the firm hedging foreign exchange risk with
Future event is very uncertain gains.
For speculators - profit from favorable exchange rate changes.
C. Using Forward or Futures Contracts
Forward or futures contracts are more suitable for hedging a known amount of foreign currency flow. Examples: accounts payable/rec
Options Sample Problems
buys a Franc put option (contract size: FF250,000) at a premium of $.01/FF. If the exercise price is $.21 and the spot at expiration is $.216, what is Ford’s profit (loss)?
REVENUES: COSTS: Sell at .21
If exercised Buy at .216 Premium + .01 Total .226 Loss: If exercised: $4,000 Loss: If not exercised: $2,500 (the original premium)