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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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Currency Options


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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


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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


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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


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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


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  • 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


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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


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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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