Currency Futures and Options Markets

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CHAPTER 8

• Currency Futures and Options Markets

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PART I

• Futures Contracts

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FUTURES CONTRACTS

• I. CURRENCY FUTURES
• A. Market History
• 1. Background
• a. Long history
• b. Extremely volatile due to
  their information driven nature
• c. The market plays a Price Discovery
  Role for other financial markets such as the
  cash markets

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FUTURES CONTRACTS

• B. International Monetary Market (IMM) 1972
• opened by the Chicago Mercantile Exchange
• Purpose
• to provide a stable market for the exchange of
  currency futures.

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FUTURES CONTRACTS

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

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FUTURES CONTRACTS

• b. Available Futures Contracts
• Currency/ 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
• in the form of a 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 movement rules
• Contracts set daily to a price
• limit that restricts maximum
• daily upward and downward movements.

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FUTURES CONTRACTS SAFEGUARDS

• f. Maintenance Margins
• When the account balance falls below the
  maintenance margin, a margin call may be
  necessary to maintain the minimum balance.

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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

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

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

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PART II
Currency Options

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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).

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3. HOW CURRENCY OPTIONS ARE PURCHASED
Premium

• Buyers SellersWriters

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

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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 give the owner the right to buy
  the currency
• 2.) Puts give the owner the right to sell
  the currency

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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. Why Use Currency Options?
• 1. For the firm hedging foreign
• exchange risk when a future event is very
  uncertain.
• 2. For speculators
• who profit from favorable exchange rate
  changes.