1. 1 FX Options Traded

2. 2 FX Options 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).

3. 3 FX Options 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

4. 4 FX Options The Specification Contract size Premium Expiry date

5. 5 FX Options 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

6. 6 FX Options Dec call, SP 1.46, premium 1 cent 2 cents 1 cent 1.43 1.44 1.45 1.46 1.47 1.48 Rate at expiry 0 - 1 cent - 2 cents Value in cents

7. 7 FX Options Which cash price is the underlying? September GBP call with SP 165 Today is June 20 th 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 at 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

8. 8 FX Options 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

9. 9 FX Options 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

10. 10 FX Options Better to sell than to Exercise Today is July 23rd We have a September GBP call, SP 165 Todays 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 = +.0562 We would need to buy GBP spot - 1.6930 Net cost - 1.6368

11. 11 FX Options Intrinsic and Time Value GBP Call at1.8250for September Current Spot1.8840 5.90 cents:Intrinsic Value Premium 6.05.15Time Value

12. 12 FX Options Time Value x Value at expiry x Out of the money At the money In the money

13. 13 FX Options Time Value SP Call underlying March Premium Intrinsic Value Time Value. 1.5001.57567.907.56.34 1.5255.485.06.42 1.5503.132.56.57 1.5751.27.061.21 1.600.31- 1.625.02-

14. 14 FX Options Time value Value Time to Expiry TodayExpiry

15. 15 FX Options Pay offs for USD I,000,000 725 720 715 GBP 710 000s 705 700 Forward 1.4286 690 1.39 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 1.53 685 680 Option SP144 675 670 Leave open

16. 16 FX Options Strategy 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?

17. 17 FX Options Strategy If yes then, 1.Puts or calls? Well what is the exposure? 2.Assuming traded options to be used -How many contracts? 3. Expiry Date? - Sometime beyond exposure date but how far? - Cost of time, versus decay, versus view of volatility

18. 18 FX Options Strategy Strike price? - In, At or Out of the money - Need to know underlying - Premium