Currency Options — Market Explainer Video

Transcript

One currency against another

A currency option references an exchange rate or a currency futures contract. A call on the euro against the dollar can benefit when the euro strengthens in that quotation. Always identify both currencies and the direction in which the pair is quoted.

A hypothetical euro call

Suppose a cash payoff example uses a one point ten dollar strike, one euro unit, and a final rate of one point fifteen dollars. The call intrinsic amount is five U.S. cents per euro. Scale that by the contract euro amount.

Scale and subtract the cost

For an illustrative ten thousand euro amount, five cents per euro is five hundred dollars of intrinsic value. If the premium was two hundred dollars, net profit is three hundred before costs. Actual contract sizes and settlement methods differ.

Spot and futures are different

Some currency options settle in cash, some deliver currencies, and many exchange traded products exercise into currency futures. The rates of both currencies affect pricing. A stock option model with no foreign interest rate can misstate the value.

Read the units first

Check pair direction, contract amount, premium currency, exercise style, and settlement. An option that looks like a small decimal quote can represent a large currency exposure. Get the units right before comparing premiums or hedges.