9 Chapter Nine Futures and Options on Foreign Exchange Chapter Objective: This chapter discusses exchange-traded currency futures contracts, options contracts, and options on currency futures. Chapter Outline Futures Contracts: Preliminaries Currency Futures Markets
Example: On Monday morning you take a long position in SF futures contract that matures on Wednesday afternoon at $0.75/SF.
1. At the close of trading on Monday the futures price has risen to $0.755. Because of the daily settlement you receive a cash profit of
$625 =125,000 x (0.755-0.75)
2. At Tuesday close the price has declined to $0.743. You must pay the $1500 loss (125,000 x [0.743-0.755]) to the other side of the contract.
3. At Wednesday close, the price drops to $0.74, and the contract matures. You pay $375 loss to the other side and take the delivery of the SF, paying the prevailing price of $0.74. You have a net loss on the contract of $1250 (625-1500-375)
You can also close out your long position with an offsetting trade, if you don’t want the delivery of the SF.
Open Interest refers to the number of contracts outstanding for a particular delivery month.
Open interest is a good proxy for demand for a contract.
Some refer to open interest as the depth of the market. The breadth of the market would be how many different contracts (expiry month, currency) are outstanding.
Highest and lowest prices over the lifetime of the contract.
Lowest price that day
Highest price that day
Number of open contracts
EURODOLLAR (CME)—$1 million; pts of 100%
Eurodollar futures prices are stated as an index number of three-month LIBOR calculated as F = 100 – LIBOR.
The closing price for the July contract is 94.68 thus the implied yield is 5.32 percent = 100 – 94.68
The change was .01 percent of $1 million representing $100 on an annual basis. Since it is a 3-month contract one basis point corresponds to a $25 price change.
The exercise price (E), also known as strike price, equals the spot price (S) of the underlying asset.
The exercise price (E) is less than the spot price (S) of the underlying asset.
The exercise price is more than the spot price of the underlying asset.
Currency options are an option on a currency futures contract.
Exercise of a currency futures option results in a long futures position for the holder of a call or the writer of a put.
Exercise of a currency futures option results in a short futures position for the seller of a call or the buyer of a put.
If the futures position is not offset prior to its expiration, foreign currency will change hands.
CaT = CeT= Max[ST - E, 0]
PaT = PeT= Max[E - ST, 0]