Currency Futures and Options Markets

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Currency Futures and Options Markets

• Chapter 8

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PART I.FUTURES CONTRACTS

• I. CURRENCY FUTURES
• Definition
• contracts written requiring a standard
  quantity of an available currency at a fixed
  exchange rate at a set delivery date.
• Private individuals are encouraged. Contracts
  have minimum price moves and daily price limits
  exist to restrict max daily price move

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FUTURES CONTRACTS

• 2. IMM (International Monetary Market) provides
• a. an outlet for hedging currency
• risk with futures contracts.

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FUTURES CONTRACTS

• b. Available Futures Currencies/Contract Size
• 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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FUTURES CONTRACTS SAFEGUARDS

• e. Maximum price movements
• 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

• 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

• 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

• Advantages of futures
• 1.) Easy liquidation
• 2.) 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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FUTURES CONTRACTS

• Profits and losses are paid over every day at the
  end of trading, a practice called marking to
  market.
• Example An investor, on Tuesday morning, takes a
  long position in Swiss Franc futures contract
  that matures on Thursday afternoon. The price is
  0,75 for SFr 125,000.
• (a) On Tuesday closing, price has risen to
  0,755.
• ? Investor receives cash profit of 625
  (125,0000,005)
• ? The initial contract is cancelled.
• ? Investor receives a new contract with the
  current price.
• The value of the contract is set to zero at the
  end of everyday.
• (b) On Wednesday, price declines to 0.743.
• ? Loss is 1500 (125,0000.012)
• ? New contract at the same price
• (c) On Thursday, price drops to 0.74. Investor
  pays 375 loss and takes delivery of Swiss
  Francs, paying the prevailing price of 0.74.

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CURRENCY OPTIONS

• PART II

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CURRENCY OPTIONS

• I. OPTIONS
• A. Currency options
• 1. Offer another method to hedge exchange
  rate risk.
• 2. First offered on Philadelphia
• Exchange (PHLX).
• 3. Fastest growing segment of
• the hedge markets.

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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 the right not the obligation to the holder
  (the buyer) to buy or sell a standard amount of
  an available currency at a fixed exchange rate
  for a fixed time period.

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CURRENCY OPTIONS

• 5. 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
• 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
• 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.
• B. Why Use Currency Options?
• 1. For the firm hedging foreign exchange risk
  with Future event is very uncertain gains.

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CURRENCY OPTIONS

• 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.

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Options Sample Problems

• Ford buys a French 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)?