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- 1. Currency Options Presentation Speculating with Currency Options
- 2. Glossary Call Option – Is a contract that grants the buyer the right, but not the obligation, to buy a fixed amount of underlying currency at a set price ( exercise price ) at or before a predetermined date ( expiry date ). If the currency fails to meet the exercise price before the expiration date, the option expires worthless. You buy a call option if you think the exchange rate will rise, or sell a call option if you think it will fall. Put Option - Is a contract that gives the buyer the right, but not the obligation, to sell an underlying currency at a predetermined price ( exercise price ) at or before a predetermined date ( expiry date ). Basically you would buy a put option if you think the exchange rate will fall and sell a put option if you think it will rise or stay stable.
- 3. Glossary Premium - The purchase price of an option. In-the-money option - Relates to call options when exercise price is below the ‘spot rate’ and to put options when exercise price is above the ‘spot rate’. For example, if Barclays Bank is trading at £5.00 then all call options with strikes of £4.75 and below and all put strikes of £5.25 and above are deemed to be in-the-money Out-of-the money option – Relates to call options when exercise price is above the ‘spot rate’ and vice-versa for put options. For example, if Barclays Bank is trading at £5.00 then all call option strikes above £5.25 are deemed to be out-of-the-money while put option strikes below £4.75 are likewise Speculation - The process of selecting investments with higher risk in order to profit from an anticipated price movement.* * Quoted from http :// www . investopedia . com /
- 4. Question 1 Describe how Barry Egan could utilize these options to speculate on the movement of the Japanese yen?
- 5. Options Utilization <ul><li>Using the Call Option </li></ul><ul><li>If the ‘spot rate’ is higher than the exercise price of the option then the option is in-the-money, Barry should exercise the option and buy ¥ at €0.0085 per ¥ </li></ul><ul><li>If the ‘spot rate’ is lower than the exercise price of the option then the option is out-of-the-money , Barry should not exercise the option and buy in the spot market. Potential loss could be; </li></ul><ul><li> ¥ 6.25m * € 0.0007 per ¥ = €4375 </li></ul>
- 6. <ul><li>Using the Put Option </li></ul><ul><li>If the ‘spot rate’ is higher than the exercise price of the option then in-the-money, Barry should exercise the option and buy ¥ at €0.0085 per ¥ </li></ul>Options Utilization <ul><li>If the ‘spot rate’ is lower than the exercise price of the option then out-of-the-money , Barry should not exercise the option and buy in the spot market. Potential loss could be; </li></ul><ul><ul><li>¥ 6.25m * € 0.0005 per ¥ = €3125 </li></ul></ul>
- 7. Question 2 Assume Barry decides to construct a “Long Strangle” (Buy Strangle) in Yen. What are the Break-Even Points of this Strangle?
- 8. Long Strangle Strategy This is one of the most popular options trading strategies. It consists in simultaneous buying of an out-of-the-money call and out-of-the-money put with different exercise prices but the same underlying currency and expiration date . Traders use this strategy when they expect a sharp swing of the exchange rate in either direction. The strangle buying strategy has unlimited profit potential if the exchange rate moves enough in either direction. The value of a strangle option increases along with the volatility of the underlying currency. Risks (loses) are limited by net premiums.
- 9. The strangle has two breakeven points. While the strangle has lower risk associated to it, the probability of profit is less when breakeven points are further away. The profit potential of this strategy is unlimited after breakeven . Upper B/E Point = Strike price of Long Call + Net Premium Paid = 0,0085 + (0,0007 + 0,0005) = 0,0097 Lover B/E Point = Strike price of Long Put - Net Premium Paid = 0,0084 - (0,0007 + 0,0005) = 0,0072 Breakeven Points
- 10. 0.0072 0.0097 Put Option 0.0084 - €7500 Profit Profit or Loss Profit Lower B/E Point Upper B/E Point Max loss Call Option 0.0085 Long Strangle diagram
- 11. Strategy Limitations <ul><li>Advantages: </li></ul><ul><li>An investor can profit from this position if the exchange rate moves in either direction. </li></ul><ul><li>The potential profits on the upside are unlimited. </li></ul><ul><li>The potential profits on the downside can be very high as well. </li></ul><ul><li>The max loss is limited to the original cost of the position, i.e. Net Debit (total premiums paid) </li></ul><ul><li>Lower net debit than the Long Straddle strategy. </li></ul><ul><li>No currency is actually owned (uncovered position). </li></ul><ul><li>Cautions: </li></ul><ul><li>If exchange rate rises above the call strike price but remains below the upper break even you will still incur a loss on the position. </li></ul><ul><li>Likewise, if exchange rate falls below the put strike price but remains above the lower break even you will still incur a loss on the position. </li></ul><ul><li>Since you are purchasing two different strikes you may need a large move in either direction to obtain a profit. </li></ul>
- 12. Question 3 What is Barry’s total profit or loss if the value of the Yen in one month is 0.0070 euro?
- 13. Profit = Price of long put – price of underlying currency – net premium paid = ( 0,0084 – 0,0070 – ( 0,0005 + 0,0007 )) * ¥6.25m = €1250 Answer € 1250 is the profit per contract
- 14. 0.0070 0.0072 0.0097 Put Option 0.0084 - €7500 Profit Profit or Loss Profit Lower B/E Point Upper B/E Point Max loss Call Option 0.0085 € 1250 Illustration
- 15. Question 4 What is Barry’s total profit or loss if the value of the Yen in one month is 0.0090 euro?
- 16. Loss = price of underlying currency - Price of long call – net premium paid = ( 0,0090 – 0,0085 – ( 0,0005 + 0,0007 )) * ¥6.25m = - €4375 Answer € 4375 is the loss per contract
- 17. 0.0090 0.0072 0.0097 Put Option 0.0084 - €7500 Profit Profit or Loss Profit Lower B/E Point Upper B/E Point Max loss Call Option 0.0085 Illustration - €4375
- 18. Conclusion <ul><li>Option contracts are one the most popular speculating instruments when market is volatile. </li></ul><ul><li>Using Long ‘Strangle’ would dramatically limit the company’s loss per option contract. </li></ul><ul><li>Options should be exercised say within a week, since the closer to the expiry date, the chances of losing the premium increase </li></ul>

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1. Initial margin =? , short strangle , Japanese Yen JY Sep'11, STO- Sep 118put@ 0.0164

STO-Sep 136call@0.0109 credit ( excluding commissions & fees) 0.0055 or (0.0055x$125000)

$687.50

2.Initial margin = ? , Bear call spread ,JY Futures trading JYU11@ 1.23730 at open

STO-Sep 1.27call@ 0.0283 , BTO- Sep 1.28call@ 0.0254 ,credit: 0.0029 or( 0.0029 x 125000)

$362.5 , breakeven B/E=short call strike + credit = 1.27 + ( 362.5 / 125000) 0.0029= 1.2729

Your comments and corrections of my calculations is appreciated. George