Foreign Currency
Derivatives and
Swaps
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Currency Options
A foreign currency option is a contract giving the
purchaser of the option the right but not the
obligation to buy or sell a given amount of
currency for a specified time period
The most important part of clause is the right, but not the
obligation to take an action
Two basic types of options, calls and puts
Call buyer has right to purchase currency (call: buy)
Put buyer has right to sell currency (put: sell)
The buyer of the option is the holder and the seller of the
option is termed the writer
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Buyer of a Put
Buyer of a Put: (see Exhibit 8.5)
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Buyer of a Put
For example, suppose that the spot price falls
to $0.575/Sfr, Hans (who bought a put option)
will buy francs at this price and sell it to the
writer at $0.585/Sfr:
Value = Strike price (Spot rate + Premium)
= 0.585 $/Sfr (0.575 $/Sfr + 0.005 $/Sfr)
=0.005$/Sfr
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Writer of a Put
Seller (writer) of a put: (see Exhibit 8.6)
The option will be exercised if the spot price of
francs drops below $0.585/SF
Below a price of $0.58/SF (break-even), the
writer will lose more than the premium received
from writing the option
Above $0.585/SF, the option will not be exercised
and the option writer will pocket the entire
premium
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Writer of a Put
For example, suppose that the spot price is
$0.575/Sfr, then the writer will experience:
Value = Premium (Strike price - Premium)
= 0.005 $/Sfr (0.585 $/Sfr + 0.575 $/Sfr)
= - 0.005$/Sfr
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