chapter 7 currency options. copyright 2004 mcgraw-hill australia pty ltd ppts t/a international...
TRANSCRIPT
Chapter 7
Currency Options
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 2
Objectives
• To introduce basic concepts.• To describe currency options
contracts.• To identify the determinants of option
premiums.• To describe exotic currency options.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 3
Definition
• A currency option is a contract that gives its holder the right to buy and sell, on or by a specified date, an amount of a currency at a predetermined exchange rate.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 4
Options Writers and Holders
• The writer sells the holder the right to buy or sell the underlying currency.
• The price paid up front is called the premium.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 5
Payment and Settlement Dates
• The premium payment date is the date on which the premium is due.
• The settlement date is the date on which delivery of the underlying currency is required.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 6
Call and Put Options
• A call option gives the holder the right to buy the underlying currency.
• A put option gives the holder the right to sell the underlying currency.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 7
The Mechanics of Call and Put Options on the Australian Dollar
Call
(a) Initial exchange
Premium (USD)
Put
Premium (USD)
Writer Holder
(b) Exercise
USD
AUDAUD
USD
Writer Holder Writer Holder
Writer Holder
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 8
Naked and Covered Options
• An option is naked if there is no corresponding spot position on the underlying currency.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 9
The Exercise (Strike) Exchange Rate
• The exchange rate at which the holder of the option can buy or sell the underlying currency
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 10
Profitable Exercise of Call and Put on Currency y
y
Writer
Holder
@ E
Spot market
x
y
@ Sx
(a) Call gross profit = S - E
Writer
Holder
@ E
Spot market
x
y
@ Sx y
(b) Put gross profit = E - S
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 11
Profitable Exercise of Call and Put Options on the Australian Dollar
AUD 1,000,000
Holder
Spot market
(a) Call gross profit = USD 50,000
S = 0.65
E= 0.60Writer
AUD 1,000,000
USD 600,000
USD 650,000AUD 1,000,000
Writer
Holder
E= 0.60
Spot market
USD 600,000
S = 0.55
(b) Put gross profit = USD 50,000
AUD 1,000,000
USD 550,000
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 12
The Settlement Exchange Rate
• The exchange rate at which the underlying currency can be bought or sold when the option is exercised
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 13
Net Settlement Payments on Successful Exercise
Writer Holder
Premium
K ( S – E )
(a) Call
Writer Holder
Premium
K ( E – S )
(b) Put
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 14
Long and Short Positions
• The holder of an option has a long position.
• The writer of an option has a short position.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 15
Expiry Date
• The date by or on which the option can be exercised
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 16
American and European Options
• An American option can be exercised before or on the expiry date.
• A European option can be exercised on the expiry date only.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 17
In the Money and Out of the Money
• An option is in the money if it can be exercised at gross profit.
• An option is out of the money if it cannot be exercised at gross profit.
• An option is at the money if the spot rate is equal to the exercise rate.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 18
Intrinsic Value and Time Value
• The intrinsic value is the extent to which the option is in the money.
• The time value is derived from the possibility that with the passage of time the option will be in the money.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 19
Assignment
• An assignment materialises when the writer receives a notice that the holder has exercised the option, in which case the writer is obliged to deliver or receive the underlying currency.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 20
Base and Underlying Currencies
• The base currency is the currency in which the option price is expressed.
• The underlying currency is the currency that is bought or sold.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 21
Margins
• A margin is the cash or securities required to be deposited by an option writer as collateral.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 22
Open Interest
• Open interest is the number of outstanding options.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 23
Opening and Closing Transactions
• An opening transaction results in opening a new position.
• A closing transaction results in liquidating an existing position.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 24
Registered Options Traders
• ROTs are participants on the exchange, trading for their own or their firm’s account.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 25
Option Quotations
• American terms mean that the underlying exchange rate is quoted in terms of the US dollar per unit of the other currency.
• European terms mean that the underlying exchange rate is quoted in terms of the other currency per unit of the US dollar.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 26
OTC and Exchange-Traded Options
• An OTC option is non-standardised, created by the writer to meet the specific requirements of the buyer.
• An exchange-traded option is a standardised option traded on an exchange.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 27
Currency Option Specifications
• Contract size• Position limit• Base currency• Underlying currency• Premium quotations
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 28
Gross Pay-offs on Option Positions
• Long call S - E• Long put E - S • Short call - (S -E ) • Short put - (S -E )
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 29
Net Pay-offs on Option Positions
• Net pay-offs take the premium into account. For example, the net pay-off on a long call is:
S -E - R
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 30
Long Straddle
• Obtained by buying call A and buying put A. It is used when the currency is expected to appreciate or depreciate dramatically.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 31
Short Straddle
• Obtained by selling call A and selling put A. It is used when the currency is not expected to move much.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 32
Long Strangle
• Can be obtained by buying call B and buying put A. It is cheaper than a straddle.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 33
Short Strangle
• Can be obtained by selling put A and selling call B.
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 34
Factors Determining Option Prices
• Exercise exchange rate • Time to expiry• Intrinsic value• Exchange rate volatility
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 35
Factors Determining Option Prices (cont.)
• Type of option• Interest rate on the base currency• Forward spread and interest rate
differential
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 36
Measures of sensitivity
• Delta: premium with respect to spot exchange rate
• Gamma: delta with respect to spot exchange rate
• Theta: premium with respect to time to expiry
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 37
Measures of sensitivity (cont.)
• Vega: premium with respect to volatility
• Rho: premium with respect to interest rate
Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 2e by Imad A. Moosa
Slides prepared by Afaf Moosa 38
Exotic Options
• Knockout options• Path-dependent options• Compound options• Chooser options