Derivatives

CHAPTER 19Foreign Currency Options

Aims

• To examine contract specifications for foreign currency options and the payoffs from calls and puts.
• To analyse the advantages and disadvantages of hedging future foreign currency receipts/payments with either futures or options
• To briefly outline some non-standard (‘exotic’) currency options.

19.1 CONTRACT SPECIFICATIONS

Most FX-options contracts are traded in the OTC market as they can be tailored to meet the needs of corporate treasurers in terms of size of the deal, currency used, and maturity dates. The exchange-traded FX options markets are much smaller in volume although exchange traded options on spot FX rates are available on NASDAQ (which was the Philadelphia Stock Exchange, now called NASDAQ-OMX-PHLX).

Most contracts traded are against the US dollar and the option premium is quoted in cents per unit of foreign currency, with the only exception being contracts on the Japanese yen which are quoted in hundredths of a cent. Delivery is the foreign currency (in exchange for USD). There are also options contracts which deliver an FX-futures contract – futures options are dealt with in Chapter 20.

For example (Table 19.1), the contract size for the (British) pound sterling (GBP) is for £31,250 and entries are quoted in cents per GBP. If the current spot rate on 26 July is then October-options would be available with strike prices ...