FX Options

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Traded
1
Definition
An option is the right but not the obligation to
buy (call) or sell (put) a currency at an agreed
rate (strike price or exercise price) over a
certain period of time. For this right a premium
is paid (usually at the start).
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Terminology
American, the option may be exercised (or not)
at any time in the option period
European, the option may be exercised (or not)
only at expiry
OTC, over the counter or bespoke options
Traded, where options are traded on an
exchange and therefore the contracts have to be
precisely specified
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The Specification
 Contract size
 Premium
 Expiry date
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In, At and Out of the Money
 GBP call i.e. (call for GBP give USD)
SP 1.43
Current Spot 1.45
1.43
1.41
Option is
In
At
Out of
the money
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5

Dec call, SP 1.46, premium 1 cent

2 cents

1 cent
1.43
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Value in
cents
1.44
1.45
1.46
1.47
1.48
Rate at expiry
0
- 1 cent
- 2 cents
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Which cash price is the underlying?
September GBP call with SP 165
Today is June 20th
Current spot is 1.6930
3 Mo fwd is 1.6785
You have two alternatives. Exercise today or sell sterling forward, Which action
will give you most profit as it is against this that the seller will base the price?
1) Exercise today Give USD1.6500 Get GBP 1
Get USD 1.6930 Give GBP 1
Net
430
Or, Sell GBP forward to expiry day and exercise on expiry
Give USD 1.6500 Get GBP 1
Get USD 1.6785 Give GBP 1
Net
285
So underlying is spot
7
Ref the underlying
 Note GBP is at a discount to the dollar
therefore is ‘strongest’ at spot so
Call = spot is underlying
Put = forward is underlying
For currencies at a premium to the USD, then vice
versa
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Effective rate
Suppose we decide to buy a GBP call i.e. will give USD to get GBP
Then if the SP is 1.65 and the premium is 1 cent the effective rate if
we exercise will be
1.65
+.01
1.66
If this had been a put but using same SP and premium, then the
effective rate would be
1.65
-.01
1.64
Note that the premium is always a cost therefore for the call we
pay more USD and for the put we receive less USD
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Today is July 23rd
We have a September GBP call, SP 165
Today’s spot rate is 1.6930
And the current premium for the option in the market
is 5.62 cents
We need the GBP today
We could exercise in which case the cost would be
(ignoring the sunk cost of the premium paid) - 1.6500
Or we could sell and receive 5.62 cents = +0.0562
We would need to buy GBP spot
- 1.6930
Net cost
- 1.6368
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Intrinsic and Time Value
GBP Call at
1.8250 for September
Current Spot
1.8840
5.90 cents: Intrinsic Value
Premium
6.05
.15
Time Value
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x
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Value at expiry
x
Out of the money
At the money
In the money
12
SP
Call
March
underlying
Time
Value.
1.500
1.5756
Intrinsic
Premium Value
7.90
7.56
.34
1.525
5.48
5.06
.42
1.550
3.13
2.56
.57
1.575
1.27
.06
1.21
1.600
.31
-
.31
1.625
.02
-
.02
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Value
Today
Time to Expiry
Expiry
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GBP
000’s
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725
720
715
710
705
700
690
1.39
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Forward 1.4286
685
680
675
670
1.40 1.41 1.42
1.43 1.44 1.45 1.46
1.47
1.48 1.49 1.50
1.51 1.52 1.53
Option SP144
Leave open
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Decide whether to use options or not
versus leave open or cover.
Issues:cost,
policy,
view of fx movements

If yes then,
1.
Puts or calls?
2.
How many contracts?
3.
Expiry Date, sometime beyond exposure date but how far?
4.
Strike price?
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If yes then,
1. Puts or calls?
Well what is the exposure?
2. Assuming traded options to be used
- How many contracts?
- What is contract size?
- Over /under hedge
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3. Expiry Date?
- Sometime beyond exposure date but how far?
- Cost of time, versus decay, versus view of
volatility
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Strike price?
- In, At or Out of the money
- Need to know ‘underlying’
- Premium
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