Muhammad Waheed

Group (J)
CURRENCY OPTIONS
MARKET
PRESENTED BY:
MUHAMMAD WAHEED (12757)
TOUQEER HUSSAIN (12761)
SADDAM KHAN (12771)
SAJID HALEEM (13411)
WASIF JAVED (13405)
• Currency Options provide the right to purchase or sell the currencies at
specified prices.
• They are available for many currencies, including the:
 Australia Dollar
 British Pound
 Japanese Yen
 Swiss Franc
 OPTIONS EXCHANGES
In late 1982, MONTREAL and PHILADELPHIA allow trading in
standardized foreign currency options
Options offered on the CHICAGO MERCANTILE EXCHANGE
(CME) and the CHICAGO BOARD OF TRADE (CBOT)
Currency traded through Globex system at CME
Currencies are traded around the clock
CME and CBOT merged to form CME group
 CME and CBOT consolidated into a single electronic trading platform at
CBOT
 Product reduced operating and maintenance expenses
 Option can be purchased or sale through brokers for a commission.
 Commission per transaction is commonly $30 to $60 for a single currency
 Commission much lower when transaction involves multiple contracts
 OVER-THE-COUNTER MARKET
 ‘’Currency Options transaction directly done between two parties
without the control of an exchange’’.
 Transactions are done by specific Financial Institution
 Offers currency options that are tailored to the specific needs of the firm
 Options are not standardized
 All terms must be specified in the contracts, e.g.
o Number of units
o Strike price
o Expire date
o Size = $5 million
 The agreement is as safe as the parties involved
 Financial Institutions require some firms seeking to purchase or sell
currency options
 CURRENCY CALL OPTIONS
 ‘’The right to buy a specific currency at a specific price within a specific
period of time’’
 Price at which owner buy the currency called Strike price or Exercise price
 In a Currency Call Options, called
• In The Money Present Spot Rate > Strike Price
• At The Money Present Spot Rate = Strike Price
• Out The Money Present Spot Rate < Strike Price
 If Spot Rate increase above the Strike Price, owner purchase the currency at
Strike Price at cheaper rate
 Buyer of a currency call option pays a premium
 Seller of a currency call option receives the premium paid by buyer
In return, seller is obligated to accommodate the buyer in accordance
with the rights of the currency call option
 Call Options quotations are summarized each day in various Financial
Newspapers
 FACTOR AFFECTING CURRENCY CALL OPTION
PREMIUMS
 Premium of a Call Option represents the cost of having the right to buy the
underlying currency at a specified price
 The Call Option Premium is (denoted C)
C = f (S - X ,T, sigma)
Here,
 S-X is the difference between the spot rate (S) and the strike price (x)
 T denotes the time to maturity
 Sigma denotes the volatility
 Spot Price Related to Strike Price:
High Spot Price related to the Strike Price, high the option price will be.
 Length of Time before the Expiration Date:
Spot rate is more likely high above the strike price , if the buyer hold
currency for long period of time.
 Volatility of the Currency:
The greater the variability in the currency’s price, the greater the spot
rate rising above the strike price.
Less volatile currencies have lower call options prices.
Touqeer Hussain Shah
HOW FIRMS USE CURRENCY
CALL OPTIONS
Using call options to hedge payables:
 MNCs can purchase call options on a currency to hedge future payables.

Using call options to hedge project bidding:

 U.S based MNC bids on foreign projects, purchase call options to lock in
the dollar cost of the potential expenses.

Using call options to hedge target bidding:

 Firms can use call options to hedge a possible acquisition.
Speculating with currency call options:
 Speculators expect foreign currency appreciate
 Purchase call options of that currency
 If currency appreciate, then speculators exercise their options by purchasing
at strike price and then sell at prevailing spot rate.
 Speculator Profit = (Selling Price – Strike Price) + Premium Pay
Break even point from speculation:
 Purchaser break even point if the spot rate at which currency sold is equal to
the strike price plus the option premium
Speculation by MNCs:
 Financial Institutions use currency options to speculate on future exchange
rate movements.
 MNCs use currency derivatives for hedging and not for speculation.
 MNCs use shareholder and creditor funds to pursue their goal of market leader
in some product or service.
 MNCs bod ensure that MNCs operations are consistent with its goals.
Saddam Khan
 CURRENCY PUT OPTIONS

• A currency put option is a hedging contract that gives the holder

the right, but not the obligation, to sell a specific currency at a
specific price within a defined period of time.
• A currency call option is the opposite of a currency put option.
 FACTORS AFFECTING CURRENCY PUT OPTIONS

• The Put Option Premium is (denoted P)

P = f (S - X ,T, sigma)
• Put option is influenced by three factors;
 Strike Price
 Length of Time
 Volatility
 HEDGING WITH CURRENCY PUT OPTIONS

• A currency put option is a hedging contract which is used to protect

themselves against depreciation of a currency.

• It protect the holders from losses due to exchange rate fluctuations.

Sajid Haleem
 SPECULATING WITH CURRENCY PUT OPTIONS
• Individuals may speculate with currency put options based on their
expectations of the future movements in a particular currency.
• For example: speculators who expect that the pound will depreciate can
purchase pound put options.
 SPECULATING WITH COMBINED PUT AND CALL
OPTIONS
• For volatile currencies one speculative strategy is to create a straddle,
which uses both a put option and a call option.
CONTINGENCY GRAPH FOR THE PURCHASER OF A
CALL OPTION
• A contingency graph for the purchaser of a call option compares the
price paid for that option to the payoffs received under various
exchange rate scenarios.
 CONTINGENCY GRAPH FOR THE SELLER OF A
CALL OPTION
• A contingency graph for the seller of a call option compares the
premium received from selling that option to the payoffs made to the
options buyer under various exchange rate scenarios.
Wasif Javed
 CONTINGENCY GRAPH FOR THE BUYER OF A PUT
OPTION
• A contingency graph for the buyer of a put option compares the premium
paid for that to the payoffs received under various exchange rate
scenarios.
• For example if exercise price is $1.50 and premium is $.03 than your
break even point is $1.47.
 CONTINGENCY GRAPH FOR THE SELLER OF A PUT
OPTION
• A contingency graph for the seller of a put option compares the premium
received from selling that option.
• An option buyer net gain will not always represent an option seller net
loss.
 CONDITIONAL CURRENCY OPTIONS
• A currency option can be structured with a conditional premium.
• Premium paid for the option is conditional on the actual movement in the
currency value over the period.
• For example conditional put option exercise price is=$1.70 trigger=$1.74
premium =$.04
 EUROPEAN CURRENCY OPTIONS
• They are similar to American-style options except that they must be
exercised on the expiration date.