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Currency Options

Currency Options. Currency Options. Meaning of a Currency Option Types of Options Classification of Options Hedging and Speculation Using Currency Options Determining profit/loss on an option. Currency Options. A contract between two parties —a buyer and a seller/writer—

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Currency Options

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  1. Currency Options

  2. Currency Options • Meaning of a Currency Option • Types of Options • Classification of Options • Hedging and Speculation Using Currency Options • Determining profit/loss on an option

  3. Currency Options • A contract between two parties • —a buyer and a seller/writer— • in which the buyer purchases from the seller/writer the right to buy or sell a currency at a predetermined exchange rate. • The buyer pays the seller a fee called the premium, which is the option’s price. • An option to buy an asset at a predetermined price (also known as exercise price) is known as the call option • An option to sell as asset at a predetermined price (also known as exercise price) is known as put option

  4. Types of Options • European Style • It can be exercised at the discretion of the option buyer/option holder only at the maturity of the option • American Style • It can be exercised at the discretion of the option buyer/option holder at any time before maturity or at maturity of the option

  5. Classification of Options • In-the-Money Option • One that would lead to positive cash flows to the holder if it were exercised immediately • At-the-Money Option • One that would lead to zero cash flows to the holder if it were exercised immediately • Out-of-Money Option • One that would lead to negative cash flows to the holder if it were exercised immediately

  6. In-Money Calls and Puts • Call is in the money if ST > E • Put is in the money if E > ST • Out of Money Calls and Puts • Call is out of money if ST < E • Put is out of money if E < ST

  7. Strategies Using Currency Options • Long a Call Option/Buy a Call Option • Buy a right to purchase a foreign currency at a predetermined exchange rate • Long a Put Option • Buy a right to sell a foreign currency at a predetermined exchange rate

  8. Hedging and Speculation • Foreign Currency Cash Outflows • Risk: Foreign currency may increase in value against domestic currency • Strategy: Buy a call option on the foreign currency • Foreign Currency Cash Inflows • Risk: Foreign currency may decrease in value against domestic currency • Strategy: Buy a put option on the foreign currency

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