CHAPTER 7 - CURRENCY FUTURES AND OPTIONS Opening story on p. 162 of Barings, oldest bank in U.K.

, got in big trouble when one of its traders took unauthorized positions in exchange-traded options and futures contracts, mostly on the Nikkei 225 Stock Index futures contracts - unhedged $27B position. Losses were close to $1B when the market moved unfavorably against the trader's speculative positions, exceeding the bank's entire equity capital, forcing bank into "administration" by the Bank of England (U.K.'s central bank). Illustrates the extreme danger/volatility of derivatives. Options and futures can be used to eliminate, reduce, hedge and manage risk, like insurance, but can also be extremely speculative. Why?? MECHANICS OF FUTURES CONTRACTS Differences/similarities between futures and forward contracts, see summary Exhibit 7.1 on p. 164: Similarities: 1. Both are derivative securities for future delivery/receipt. Agree on P and Q today for future settlement or delivery in 1 week to 10 years. 2. Both are used to hedge currency risk, interest rate risk or commodity price risk. 3. In principal they are very similar, used to accomplish the same goal of risk management. Differences: 1. Forward contracts are private, customized contracts between a bank and its clients (MNCs, exporters, importers, etc.) depending on the client's needs. There is no secondary market for forward contracts since it is a private contractual agreement, like most bank loans (vs. bond). 2. Forward contracts are settled at expiration, futures contracts are continually settled, daily settlement. 3. Most (90%) of forward contracts are settled with delivery/receipt of the asset. Most futures contracts (99%) are settled with cash, NOT the commodity/asset. 4. Futures markets have daily price limits. FUTURES CONTRACTS Currency Futures Contracts are standardized contracts, with fixed, standardized contract sizes and fixed expiration dates, that are exchange-traded, i.e., traded as securities on organized exchanges. Futures contracts have secondary markets, can be traded many times during life of contract, like a bond (vs. bank loan). See Exhibit 7.2 on p. 167. Contract Examples: Yen contracts: ¥12.5m (approx $126,000), Pound: £62,500 (approx. $100,000), Euro: €125,000 (approx $160,000), SF: 125,000 (approx $106,000), etc. Expiration dates: March, June, Sept, and December on the 3rd Wednesday. Note: If you wanted to hedge receipt/payment of £100,000, you would have to either do a partial hedge of £62,500 (1 contract) or "over-hedge" with 2 contracts for £125,000 total.

BUS 466/566: International Finance – CH 7

Professor Mark J. Perry

you would have to put up about $3. for Canadian dollar (CD) futures contract.600 (about 75% of $3. payoff diagram. Reversing Trade involves taking an offsetting position.. MNCs. Futures contracts are like "side bets. If the CD rises (falls). neutralizes. the buyer/long will have their margin account increased (decreased). with no business interest in the underlying commodity/currency. If the CD falls (rises). To buy one U. neutralizes your contract. exporters. 99% are "settled with cash" by a "reversing trade. you get a cash settlement from your auto insurance company. banks.K. In forward contracts. See Exhibit 7. which closes out. the hedger is "selling" their risk to the speculator. the short (seller) delivers the asset to the buyer (long). not a new car or body work. Like buying insurance." 90% of forward contracts involve an exchange of currency. 90% of settlements involve an actual exchange of assets. p. 2.g. pound futures contract. Buyer (seller) will gain (lose) when the settlement price rises (falls).someone with a business/personal interest in the underlying currency. you take a short (sell) position to close out you are then selling to yourself. the contract is actually settled in cash continually throughout the contract.500). In futures contracts. 170. 2 BUS 466/566: International Finance – CH 7 Professor Mark J.000. so the exporter can convert foreign exchange into US dollars." usually 70-75% of the initial margin.pure speculative bet/investment using futures contracts. Hedgers . etc. every gain is exactly offset by a loss of the same amount. importer at an agreed upon rate. your futures position. TWO PARTICIPANTS IN FUTURES 1. e. which is only about 3. eliminate or control currency risk." Because of daily settlement. and is using futures trading to minimize. so the importer can pay for merchandise. If a hedger is short (long) and a speculator is long (short).4. you could never let your account go below $2. If you are long (buy). Examples: the bank sells DM to the U. Or the bank buys Yen from the exporter at an agreed upon rate. Futures trading is a "zero-sum" game. Speculators . forward contract. Daily settlement (marked-to-market): Futures contracts are revalued daily depending on the daily settlement price (ex-rate). the seller/short will have their account increased (decreased). If you can't make margin call. importers.S. You would also have to keep a "maintenance margin. the person who is short (seller) actually delivers FX to the long (buyer). only 1% of contracts are settled with the underlying asset. Difference: Profits/losses for a futures contract accumulate on a daily basis vs. where profits/losses are realized all at once at contract expiration.5% of the contract value of $100.Initial Performance Bond (formerly called margin): The initial investment required to establish a futures position. Every futures contract involves a buyer (long) and a seller (short). and you exit the market.500. Perry . In this case. your contract is liquidated by broker.

milk is $.75 per hundredweight. "round-trip" commission. reversing trades allows a hedger to time their own expiration of the contract to coincide with the underlying business activity . Dec). Most currency futures have no limits. Sept. and individual traders are protected from default. Settlement will be in cash. "Circuit breaker" to limit large losses in one day. June. Live cattle and hog futures limits are $. the parts will cost $12.2550/€.. For example. Daily Price Limit .05/lb. Futures exchanges like CME act as third party "clearinghouses" to facilitate futures trading. many interest rate futures have a 200 point limit. the ex-rate will be _______ and the parts will now cost _________.500. not Forward contracts. monitor and maintain the margin accounts.000 ($1. Traders do not then have to evaluate the creditworthiness of the other party to the transactions. Perry .2550/€ Loss $/€ Spot Rate at Expiration (90 days) Short 3 BUS 466/566: International Finance – CH 7 Professor Mark J.. Suppose that 3-month euro futures contracts are priced at $1.e. and do not have to deal directly with each other. If the settlement price changes by the daily price limit. which includes starting and ending the position. not euros. The Clearing Members guarantee the trades. Reversing trade is included. set by the exchange. so GM would need 80 contracts to cover the €10m (€10 m / €125.000 = 80). Worried? Over the next three months: $______ and € ______ . suppose the spot ex-rate is $1. Euro contracts are for €125.03/lb. GM would take a _________ position to hedge against the euro __________.Since currency futures contract expire on only four days per year (third Wed. If the euro appreciates by 4% over the next three months. importing. exporting. Long Profit F90 = 1. trading is stopped until the next day. Buyers and sellers trade through the clearinghouse as a third party.feature of Futures. Commission: As low as $15 per currency futures contract.25/€ and remains constant for 3 months. an increase of _________. in Mar.000. Using Currency Futures for Hedging GM has to pay €10m in three months for a delivery of parts from Germany invoiced in euros.25/€ x €10m).g. butter is $.

b.000. Currency futures also trade on CME's 4 BUS 466/566: International Finance – CH 7 Professor Mark J. Perry . settlement in cash CURRENCY FUTURES MARKETS Currency futures started trading in 1972 at the Chicago Mercantile Exchange (CME).55m. and many cross-rate contracts are now available for Euro vs.000 loss. and some mortgages (led to "points"). GM will separately: a) settle the futures contracts. At CME.255) x €10m = -$550. 3. to 2 p.45m (futures) profit = $12. then it would actually buy the euros at $1. 1960s and early 1970s.m. 2-3% in the 1950s. Inflation and interest rates rose and became volatile in the 1970s. Req. Forward contracts: Lock in a rate.20 – $1.$. b. commodities and real estate) Why then for currency futures? Actually. Yen and SF (14 cross-rate contracts).m. Gain on futures ($1. which opened in 1898 (largest futures exchange in U. Even though GM locks in an ex-rate of $1. GM will separately: a) settle the futures contracts. settle the futures contract in CASH. weather. See WSJ handout and CME website: http://www. 1. settlement in currency (buy or sell foreign exchange) Futures contracts: Lock in a rate.55m (or $1. 6 product areas: stock indexes. interest rates.255/€) Suppose the euro is $1. Interest rates on T-bills were low and stable 1-2%. Fixed ex-rates were abandoned.20/€ in 3 months. 5. GM guarantees an ex-rate of $1. Oil prices doubled and tripled in the two oil shocks of the 1970s (1974-75 and 1979-80).000) Net cost of buying the euros: -$12m (spot) . currency. Q was eventually repealed. It will buy the 10m euros in the spot market in three months and at the same time.. a.cme. Purchase €10 million @ $1. If GM entered into a forward contract at $1.20 = ($12. and b) buy the euros in the spot market. Q) and checking accounts (i = 0%).com/. currency futures are traded daily (M-F) from 7:20 a.255) x €10m = +$450. Inflation was low and stable. regardless of what happens to the euro.30 per euro = ($13. it doesn’t actually buy euros at that rate. Interest rates were fixed by federal law for savings accounts (Reg. started to float.55m (futures) loss = $12.255/€.30 – $1.Suppose the euro is $1. Real.55m (or $1.255/€ and a total cost of $12. Loss on futures ($1. Recent changes: Euro. BP.30/€ in 3 months. Price of oil was low and stable. Fixed exchanges rates until 1973 meant no currency risk. and b) buy the euros in the spot market.255/€) CONCLUSION: With futures contracts at $1. 4. a.000.255. Purchase €10m @ $1. 2. Economic and financial volatility increased dramatically in the 1970s.S. Led to an explosion in the derivative markets for futures contracts.255/€.255.000 profit.000) Net cost of buying the euros: -$13m (spot) + $. trading in many derivative markets started to explode in the 1970s.

the next day. $/¥. Budapest and Korea.8054.8475/¥100.8495) and Low ($. etc. (5:00 on Sundays) and go until 4 p. they are both efficient markets for determining the expected future value of currency.Reading Futures Quotations: June 2005 C$ (CD) futures opened at $.m. and you are always going long (buying ¥) or short (selling ¥) on the FOREIGN CURRENCY.m. and therefore S = $0.8057 Futures (not exactly 30.3 on p. a measure of demand. However.0023/CD = $230.4 on p. almost 24-7. $/€.8043 180 days . Prices quoted are Open.8054). Almost all CME products now trade on GLOBEX. Perry . settled at $. and the Open Interest. 2005). Open Interest: The number of outstanding contracts (long and short). see Exhibit 5. Contracts are always stated in American terms. Daily settlement. i. with the $ on top. Forward 30 days $.GLOBEX electronic trading system (introduced in 1992). one hour closing for scheduled daily maintenance. 90. Mexico. High. Note that the same pattern emerges in both the forward market and the futures markets for the CD.8070 5 BUS 466/566: International Finance – CH 7 Professor Mark J. 168 to understand how currency contracts are reported at CME. See Example 7. Most currency futures contracts start trading on GLOBEX at 5 p. When the Yen gets stronger (weaker).7150) for the June 2005 contract. not the USD ($). Most interest is in the nearby contract. open interest would approach zero.8077 to $. the one expiring next (March). Open Interest (8. while CME is open. Lifetime High ($0. so they multiply x 100. Currency option contracts start trading on GLOBEX at 2:30pm.8037/CD 90 days . p. $/£.8046/CD . Currency futures also traded at the Financial Exchange in NYC. 115 for forward ex-rates.0023 from the previous day ($.742 contracts outstanding). CURRENCY FUTURES RELATIONSHIPS See the inside back cover and Exhibit 7. Reason: Long position is always the buyer. US $ depreciates. Even though the mechanics of the forward and futures markets are slightly different. Reason: S ≈ ¥118/$. Low.008475/¥. it is quoted as $ per ¥100.m. 169 . marked-to-market would mean that the shorts (longs) would have $230 added to (subtracted from) their account.e. From the Change column.1. Lifetime High and Low. Notice for Yen.8078/CD. Brazil. = CD100. 180 days) $0. (March 16. Settle. it is expected to appreciate. the ex-rate gets larger (smaller). short position is always the seller.000 x $-. but then stop trading at 7:05 a. and it would be quoted as $0.8054 . as we got closer to expiration. and for Mexican peso it is $ per MXN10. as traders took reversing trades to close out positions. Change (from settle on the previous day to settle next day). we know that price fell -$.

Why? Eurodollar futures contracts are for a Eurodollar Time Deposit having a principal value of $1.000.2 on p.01. see Exhibit 7.45% to 3.000 CDs for $80.LIBOR (3-month rate). One of the most popular futures contract is the Eurodollar Futures contract.01% or . expiration.8200/CD in June 2005? Then the long profits ($.8200 . Since the CD fell below $. Minimum price change is 1 basis point (bp). Perry .44%.7900/CD) x CD100.10% that is a +10 bp change. the profits/losses would accumulate continually during the 3 months.540 but can only sell them in June at the spot rate for $79.8054) x CD100. LIBOR is expected to be 3. Same for long-term interest rate risk using T-bond futures contracts. June. If interest rate change from 5. with a three-month maturity at the 90-day LIBOR interest rate. the short would gain $1540 and the long would lose $1540. so for 90-day LIBOR. and Dec.000 CDs for $80. they have locked into the $.56 (100 – 3. 6 BUS 466/566: International Finance – CH 7 Professor Mark J. the contract value changes by $25. on the PRICE of Eurodollar deposits. The seller (short) has agreed to sell 100. profit of $1540. 172.540 and can buy them at the spot rate for $79.000 = $1460 and the short loses $1460. 170: Suppose a speculator takes a position on March 3 for one June 2005 contract at $. Remember previous example of a bank exposed to interest rate risk because the maturity of loans > maturity of deposits.00% to 5.000 = $1540 gain or ($1540) loss. you go LONG (SHORT) on Eurodollar futures PRICES. Contracts are settled in cash. Prices (F) are stated as: F = 100 . That is. Contracts are used to hedge against interest rate risk (or speculate).000. Example 7. that is a -20 bp change. 171 that Settle = 100 – Yld. you take a position and go long or short.8054/CD . rates falling (rising) as a lender/saver/investor (borrower).000. Actually. you go long/short on T-bond prices.Example 7.7900/CD. prices are quoted as of March 4. and $1540 would be the net gain/loss during the holding period. p. 3 months in the future.3.0001 or . (see Exhibit 7. If interest rates change from 3. For hedgers. loss of $1540. EURODOLLAR INTEREST RATE FUTURES Almost 50% of all futures contracts are for debt (bond) contracts. out to December 2011. to hedge interest rate risk.44). The buyer (long) has agreed to buy 100.0001) x $1m (contract amount) = $100 annually. indicating that the risk most often hedged is interest rate risk. guaranteed rate. more than 8m outstanding contracts.25%. If you are worried about int.5 on p. NOT long or short on interest rates. What if the ex-rate turns outs to be $.01%. resulting in a settle price for June 2005 futures contracts (F) of 96. 100 basis points = 1% = . If the actual spot ex-rate in June 2005 turns out to be $. For June 2005. For every one basis point change. Note on p. for March. Worried about? Interest rates rising.8054/CD exrate and can either buy CD or sell CD at that fixed.8054.$.4). Sept.000. 2005.8054/CD.$. 171. it would be $25 ($100 / 4) for 3 months. not actual bank CDs. which is . Profit/Loss = Δ Basis Points x $25 Logic: 1BP (. The profit/loss would be ($.

P = 96. 3-month LIBOR is only 3. but would have lost money on the futures contract. Current 3-month LIBOR is 2. p. there will be a loss on 7 BUS 466/566: International Finance – CH 7 Professor Mark J. the MNC would receive $24.000 futures profit = $172.).Example 7. Note: An alternative formula for the profit/loss on a Eurodollar contract is: Δ Basis Points x $25.44% in June 2005. or (49 basis points x $500 lost interest income per bp = $24. Now the $20m will only generate $20m x (3. if interest rates stayed at to 3. there will be a profit from the futures contract to make up the difference.0001 x .000 of interest income.50).0295 x . No matter what happens to market int. the MNC will lose $500 in interest income ($20m x .F) x 100bp x $25.50 (100 . offsetting the additional interest income. Per Contract: (S .44%). the treasurer has locked in @ 3.000 profit. For example.10%.3. 1) Company invests at whatever the current.25 = $172. Perry .000 of interest income. Example: Assume at expiration. or spot. This strategy will guarantee interest income for 3-months of $20m x . 2005 that his/her MNC will receive $20m in June 2005 from the sale of merchandise. and expected 3-month LIBOR in June 2005 according to futures trading is 3. 34%. General Formula for Profit/Loss from 3-Month Eurodollar.0344 x . However.500).90 96.000 at 3.4 of Eurodollar Futures Hedge.5% x . takes a LONG position (BUYS Eurodollar futures contracts @ 96.44% three months ahead of time. Now the $20m will generate $20m x (3. $172. Eurodollar prices going UP). rates going DOWN.56 to lock in 3.44% (49 bp higher). To hedge the entire amount of $20m. regardless of what happens to interest rates.10% = . P = 96.44%.25 years) = $175.10% (what they are worried about). which is a 34 basis point change (3. $155.95% in June 05.25 = $500). and these funds will need to be invested for 3 months in the money market.3.90 (100 3. Or: The change in interest rates is 3. Interest rate risk without Eurodollar futures: For every bp (. where F = Futures Price (Settle) of the Contract. Assume at expiration.500 vs. 3-month LIBOR is 3. rates in June 2005. Treasurer decides to lock in at that rate to eliminate interest rate risk (Worried? Int.0001) below 3.56) x 100 bp x $25 = $850 profit per contract x 20 contracts = $17.10).01%. Eurodollar interest rate prevails in June 05. Remember that one basis point = . However. and the rate and income are guaranteed and locked. or change to any other rate. so . he/she buys 20 Eurodollar contracts @ $1m. which b) then guarantees the $172. and S = Spot Price of Eurodollars at Expiration.44% rate).10% / 4) = $155.000 interest income + $17.000 profit.500 less in interest income ($20m x . Profit from futures = (96.50%. 172: Treasurer learns on March 3.44% interest rate has been guaranteed with the Eurodollar futures contract. Note: There are actually 2 parts to the outcome. If market (spot) Eurodollar interest rates had risen above 3.95% (see Eurodollar quote on inside book cover of textbook).000 interest income. Profit = 34 basis points X $25 = $850 profit per contract x 20 contracts = $17. which is the same as 34 basis points.000 interest income. Interest rate can fall to 1% or rise to 5%.44% . the company would have gotten more interest income than $172. Main Point: a) The 3.25 = $147. No risk. 2) The company settles Eurodollar futures contract in cash.34% would be 34 basis points.

50 ($30 + $3. to buy/sell a specific amount of an asset (or currency) at a specified price or ex-rate (strike price). but are not obligated. See diagram below: Payoff Diagram for January 2007 $30 Ebay call option. 2007. Mortgage .Contract that gives the owner the right.the futures contract.50 8 BUS 466/566: International Finance – CH 7 Professor Mark J.50).50 . so 6 x $25 = -$150 x 20 contracts = -$ have the right. to pay off the mortgage early (callable). but not the obligation. For example.000.50%).50). "Side Bet. $175.000. If P ≤ $30. they get $172.96.44% on $20m. before anyone else.000 interest income . Right of first refusal . You will exercise the option if P > $30.$3. it will expire worthless and you will lose the premium ($3. called the Premium. Call Option .the right. and earn 3. you have to pay a option to BUY an underlying asset (stock or currency) at an agreed upon price (Strike Price or Exercise Price) on or before the expiration date. but not the obligation.000 futures loss = $172. Convertible bond .56) x 100 bp x $25 = -$150 profit per contract x 20 contracts = -$3. Premium = $3.50 (premium) you could buy one call option that would allow you to buy a share of Ebay for $30 (strike Price) on or before January 19.000. to convert your bond into stock. Gives you the right to decide later whether to buy/sell/exercise your option. for $3. 2006). on or before some date in the future (expiration)." Option . Since this option has economic value. without necessarily ever owning the asset. and about 60 different options were trading for Ebay. and you will make money if the P > $33.44% to 3. derives value from price movements of an underlying asset. Or: The change in basis points is 6 (3. or TV show. CURRENCY OPTIONS Another derivative security.000 of interest income. real estate. 27. No matter have a prepayment option . Example: Ebay was selling at $32/share (Oct. option that gives you the right to buy an asset. Loss from futures = (96. Perry . you will not exercise the option. for 3 months.

Perry . Premium = $3. put will expire worthless for buyer.50 -$3.50 Loss Call Writer Like futures trading.30 ($35 – $3. you will exercise but lose money if P is between $31.70 Put Seller $3. Example: Ebay $35 Jan 2007 puts are selling for $3.7 0 $31. The buyer of the option purchases it from the seller or the person who "writes" the call.$35. If you buy 1 Ebay put.3 0 $35 -$3. option trading is a zero-sum game. you will make money if Ebay stock P < $ the owner the right. You will exercise if P < $35. Payoff Diagram for January 2007 $35 Ebay put option. If Ebay P > $35.70 (premium).70 Put Buyer 9 BUS 466/566: International Finance – CH 7 Professor Mark J.30 . Options are traded in units of 100 shares.70).Call Buyer Profit Call Buyer $3. but not the obligation to sell an underlying asset at a stated price on or before the expiration date.50 $30 $33. Put Option .

To cancel out the futures position before expiration. p.7. Perry . 175. If not. delivery or receipt of the currency will take place.5B/day) for exchange-traded currency option contracts.time zone differences in Asia. PHLX). contract size. the size of most currency trades in the spot market. Options in OTC can be customized for the traders . In addition. £31. banks. usually in large amounts of $1m. Dec cycle with original maturities of 3.Two types of options: American (can be exercised any time at or before expiration) and European (can ONLY be exercised at expiration). Exercise of a currency futures option results in a LONG futures position for the Call Buyer and the Put Writer (seller) and SHORT futures position for the Call Writer and the Put Buyer. 173 for contracts. exercise price. "Side bet on a side bet. one and two month contracts are also traded so that there are always 1. CALL OPTION EXAMPLE 7.. 24. currency options have been traded on the Philadelphia Stock Exchange. $45. OTC trading ($117 billion daily) is larger than organized-exchange trading on the Philadelphia exchange ($2. with options traded on the two earliest months.6 on p. Europe/currency crises).. not on organized exchanges.500. e. long term option contracts are traded for 18.5. 12 months. Also.000 max contracts. Option contract sizes are half of the futures contracts. lower transactions cost.000 avg. Since 1982.250 instead of £62. Contracts are now trading for Oct. 30. p. Contracts are traded on a March. Sept. CURRENCY FUTURES OPTIONS CME offers (American) options on its currency futures contracts. option contracts would trade for Jan. CURRENCY OPTIONS MARKETS Currency options were originally traded OTC (dealer network). not the actual currency. investment banks. brokerage houses." The cycle is the same for futures options as for futures . Nov and Dec expiration on December currency futures contracts. it operates 24 hours/day (necessary now in global market .500 per contract) listed in Exhibit 7.maturity. June. PHLX limits traders to 100. 175 Consider the euro call options for June 2005 (€62. Example: In Jan.Mar. approx $60. Feb and March expiration on March futures contracts. 36 months. the trader can make an offsetting trade. Currency traders were intl. more efficient. 9. 6.000.g. Big currency traders (banks) prefer OTC market. June. Sept and Dec. The underlying asset is a currency futures contract. 2 and 3 month contracts. 10 BUS 466/566: International Finance – CH 7 Professor Mark J. see Exhibit 7. contract size is much bigger ($1m vs.

868. If the euro sells at $1.750 .3459/€ ST ($/€) (Break Even = Ex-Price + Premium) Loss Suppose at expiration.8A on p. Two ways to calculate profit from call option: 1. or $. which would be the gain to the writer (seller) of the call.500 . Perry . with an Exercise Price = 130¢/€ or $1. if you use dollars: Profit Ex-Price $1.30 + $. see Exhibit 7.$1.75). You control about $81. but you would lose ($1.500 = $3. you lose the premium of $2. and have the right to buy EUR for 130¢ or $1.30 on or before June 24.36 on expiration. For example.75.$1.30/€).30 and then sell at $1.59¢ per euro now.36 .750 (62.Exercise Price) x €62.PREMIUM Profit = ($1. For example. Profit = Spot Price .$2868. vs.500 x $0. The option contract will make money for a call buyer if S > 134.868.75.0459).75 in March that gives you the right to buy euros @ $1. losing the entire premium of -$2.06). 176. Profit = (Spot Price .25.30 and $1. for gross profits of $0.36 .868.5% of the underlying value of the currency.500 x $.868. Note: you can either use cents or dollars. The writer (seller) of the call option would lose $881.3200 .$1.25 PROFIT 2.865.59¢ or $1. You have paid a premium of $2.3459 at expiration.30/€ | -$.500 = $881. you have a net profit of $881. but you would lose money. If spot rate at expiration is only $1. S = 136¢ per euro.25 / $2. which gives you the right to buy euros at $1. you would exercise call option.0141/€ x €62.3459) x €62. you will make money. you would exercise call to minimize loss.75 (Profit / Investment) = 31% for 3 months.30) x €62.36.25 PROFIT ROI: Your return on investment (ROI) would be $881.75.59¢ per € ("cents per unit").3459 ($1.868.Premium = 4.30 + $0. Note: If the spot rate was between $1.500 = $881.30/€) with only $2.3200/€ in June.75 = $881.250 worth of euros (€62.($1.30.0459/€ = $2. You pay a premium of 4.75 without exercising. 11 BUS 466/566: International Finance – CH 7 Professor Mark J.75 by exercising call.25 per contract.29/€ (or any rate < $1.500 Profit = $1. you can exercise your right to buy @$1.06 per euro.30. or 3.868.0459/€.868.25 ($3.30/€. One contract costs €62. the option expires worthless.750 $2.75.0459) = $0.36/€.3459) x €62.0459 | $1. or $1.36 . ($1.500 x $1. if S = $1.618. Subtracting the cost of your option premium of $2. or a 124% annual ROI! Illustrates leverage. or a total profit of $3.500 = -$1.(Exercise Price + Premium) x €62.

500 = $1.50. You have paid for the right to sell Euros for 130 cents ($1.94 cents (or $0. Go short on a EUR futures contract b.0099 profit per Euro x €62. for a $. Profit = (Exercise Price .75 PROFIT HEDGING STRATEGIES USING FUTURES AND OPTIONS for CURRENCY RISK For currency risk.50 per contract.S) x €62.S] x €62.50 (see Exhibit 7.50 for the right to sell Euros at $1.06¢ ($1.500 = $1.$1.9A on p.500 at the spot rate of $1. so your net gain/profit is $1. which would be the profit for the put writer.30 (130 cents).0094) .50 = $618.7 (p.25. and you have the right to sell at $1. Write a call option on EUR d. However. or $1.25 – $587.2807. If S = $1. Perry . If you are worried about € (EUR) falling ($ rising) in value. If spot rate S = $1.500 x $0. 178). you will make money if spot rate S > 129.206. e..500 . Buy a put option on EUR futures e. If you sell (write) the put.30.30 .0099 x €62.2807) x €62. U.0193 x €62.500 Profit = ($1. If you buy the put.30) in June.$.25¢) on expiration. you could go the following: a.$1.206. Importer paying in EUR in 3 months. contract size of €62. and the max gain is the premium of $587.30 .0193/€ profit x 62. (€62.99 cents or $. with a strike price of $1.500 = $618.g. Buy a put option on EUR c.25.75 PROFIT 2. you could do the following: 12 BUS 466/566: International Finance – CH 7 Professor Mark J. Total Premium is $587.2906/€ (see Exhibit 7.75.94 cents).06¢. the put owner would not exercise option and lose the premium of $587.3025 (130. If you are worried about EUR rising in value ($ falling). Profit = [(Exercise Price .2807 = $0.2807) x €62.S.0094 x 62. 1.5.500 = $618.0094).0094). 175). Or you can calculate profit in one step: ($1.25 .500 = -$587.Premium) .30 . 1.07 cents = .206. gross profit would be $1.$1. you paid $587. and the break-even point is 129.$587.500 = $618.206.g.75 Profit (or 129.500.06¢ (130 – 0.2807/€.PREMIUM Profit = ($1. US Exporter receiving EUR in 3 months. e.PUT OPTION FOR CURRENCY Look at the June put option for Euro in Exhibit 7. and a premium of 0. Max loss is premium of $0. Write a call option on EUR futures f.75 Total Profit. you could use the following strategies. Logic: You can buy €62.9B).2807 = $.2906/€) by June.$1.2906 . you will make money if spot rate for € < 129.06 cents – 128. Enter into a forward contract to sell EUR forward 2.500 = $1.50 = $618.30.

Write a put option on EUR futures contract f. 2011 13 BUS 466/566: International Finance – CH 7 Professor Mark J. Buy a call option on EUR c. Write a put option on EUR d.a. Perry . Buy a call option on EUR futures contract e. Enter into a forward contract to buy EUR forward Updated: April 17. Go long on a EUR futures b.

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