Currency Futures and Options Markets

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Currency Futures and Options Markets

• Chapter 7

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PART I.FUTURES CONTRACTS

• I. CURRENCY FUTURES
• A. Background
• 1. Long history
• 2. Extremely volatile due to information
  driven nature
• 3. Price Discovery Role

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FUTURES CONTRACTS

• 1972 Chicago Mercantile Exchange opens
  the International Monetary Market. (IMM)
• Purpose

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FUTURES CONTRACTS

• 2. IMM provides
• a. an outlet for hedging currency
• risk with futures contracts.
• Definition
• contracts written requiring
• 1. standard quantity of an available
  currency
• 2. at a fixed exchange rate 3. at a set
  delivery date.

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FUTURES CONTRACTS

• b. Available Futures Currencies/Contract Size
  (p. 211)
• 1.) British pound / 62,500
• 2.) Canadian dollar /100,000
• 3.) Euro / 125,000
• 4.) Swiss franc / 125,000 5.) Japanese
  yen / 12.5 million
• 6.) Mexican peso / 500,000
• 7.) Australian dollar / 100,000

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FUTURES CONTRACTS

• c. Transaction costs
• commission payment to a floor trader
• d. Leverage is high
• 1.) Initial margin required is
• relatively low (less than 2 of
• contract value).

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AD BP CD EC JY MP SF
Size 100, 000 62, 500 100, 000 125, 000 12, 500, 000 500, 000 125, 000
IM 1,485 1,350 608 2,025 2,025 3,125 1,452
MM 1,100 1,000 450 1,500 1,500 2,500 1,075
Trade March June Sept Dec
Hrs 720 AM To 200 PM
P.211
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FUTURES CONTRACTS SAFEGUARDS

• e. What are the safeguards?
• 1.) Contracts set to a daily price
• limit restricting maximum
• daily price movements.
• 2.) If limit is reached, a margin
• call may be necessary to maintain a
  minimum margin.

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FUTURES CONTRACTS SAFEGUARDS

• 3.) Marking to Market
• 4.) Eliminating default
• 5.) Delivery cancelled

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FUTURES CONTRACTS

• g. Global futures exchanges
• 1.) I.M.M. International Monetary Market
• 2.) L.I.F.F.E.London International Financial
  Futures Exchange
• 3.) C.B.O.T. Chicago Board of Trade
• 4.) S.I.M.E.X.Singapore International
• Monetary Exchange
• 5.) D.T.B. Deutsche Termin Bourse
• 6.) H.K.F.E. Hong Kong Futures Exchange

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FUTURES CONTRACTS (p.214)

• B. Forward vs. Futures Contracts
• Basic differences
• 1. Trading Locations 6. Quotes
• 2. Regulation 7. Margins
• 3. Frequency of 8. Credit risk
• delivery
• 4. Size of contract
• 5. Transaction Costs

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FUTURES CONTRACTS Why would you use them?

• Advantages of futures
• 1.) High leverage(2)
• 2.) Easy liquidation
• 3.) Well- organized and stable market.

• Disadvantages of futures
• 1.) Limited to 7
• currencies
• 2.) Limited dates
• of delivery
• 3.) Rigid contract
• sizes.

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CURRENCY OPTIONS

• PART II

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CURRENCY OPTIONS

• I. OPTIONS
• A. Currency options
• 1. offer another product to hedge exchange
  rate risk.
• 2. first offered on Philadelphia
• Exchange (PHLX).

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CURRENCY OPTIONS

• Buyers SellersWriters

Premium
Buy
Sell
Buy
Sell
PUT
CALL
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CURRENCY OPTIONS

• 4. Definition
• a contract from a writer ( the seller) that
  gives
• a. the right not the obligation to the holder
  (the buyer) to buy or sell
• b. a standard amount of an available currency
  at
• c. a fixed exchange rate for a fixed time
• period.

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CURRENCY OPTIONS

• 5. Two Types Expiration Dates of Currency
  Options
• a. American
• exercise date may occur any
• time up to the expiration date.
• b. European
• exercise date occurs only at the expiration
  date and not before.

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CURRENCY OPTIONS

• 7. Exercise Price (exchange rate)
• a. Sometimes known as the
• strike price.
• B. The exchange rate at which the option
  holder can buy or sell the contracted
  currency.

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CURRENCY OPTIONS

• c. Types of Currency Options (whether you can
  buy or sell)
• 1.) Calls
• 2.) Puts

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CURRENCY OPTIONS

• 8. Status of an option
• a. In-the-money
• Call Spot gt strike
• Put Spot lt strike
• b. Out-of-the-money
• Call Spot lt strike
• Put Spot gt strike
• c. At-the-money
• Spot the strike

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CURRENCY OPTIONS

• 9. What is the premium the price of an option
  that the writer charges the buyer.

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CURRENCY OPTIONS

• B. Why Use Currency Options?
• 1. For the firm hedging foreign
• exchange risk with
• Future event is very uncertain
• gains.
• 2. For speculators
• - profit from favorable exchange rate
  changes.

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CURRENCY OPTIONS

• C. Using Forward or Futures Contracts
• Forward or futures contracts are
• more suitable for hedging a known amount of
  foreign currency flow.
• Examples accounts payable/rec

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Options Sample Problems

• Ford buys a Franc put option (contract size
  FF250,000) at a premium of .01/FF. If the
  exercise price is .21 and the spot at expiration
  is .216, what is Fords profit (loss)?

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SOLUTION

• REVENUES Sell at .21
• COSTS If exercised
• Buy at .216
• Premium .01
• Total .226
• Loss If exercised 4,000
• Loss If not exercised 2,500
• (the original premium)