The concept of currency options in Currencies Trading is quite similar to index options.
Specifications of US Dollar – Euro optionsSimilar to index options, currency options in currencies trading have four predetermined specification:
The underlying asset – in US dollar- euro options, for example, the underline asset is €62,500
The option type – C (Call) or P (Put).
The strike price – the price that the investor purchasing the option must pay when exercising the option.
The expiration date – in the case of US dollar-euro options, the Friday preceding the third Wednesday of the expiry month.
Abbreviated Option Name
Each type of option has a special symbol, and each strike price has its own ticker symbol. The symbol for US dollar-euro options is ECU. A letter designating the month and the strike price is added to that symbol.
Underlying asset price
The underlying asset price is calculated by multiplying the most recent dollar-euro exchange rate by the number of euros. For examples, if the exchange rate is $1.20/€1, then the value of the underlying assets is $75,000.
The exercise price is denoted in multiples of $0.01. A strike price of 120 means $1.20/€1. For example, a Put 120 option confers on its owner the right to purchase €62,500 at $1.20/€1.
The premium is calculated by multiplying the contract price by the size of the contract. For example, the price of a Put 120 is $0.002/€1. The premium to be paid will be calculated by multiplying the option price by the contract size: 0.015 x 50,000 = $750
Uses of USD – Euro Options
Consider the following:
On January 1, 2008, the dollar was traded at $1.50/€1.
On that same day, an investor had $150,000 in cash, equivalent to €100,000.
The money was invested in a savings account bearing a 1% monthly interest.
The investor knew that he would need €100,000 on December 31, 2008. It was therefore important for him to maintain the value of his assets in Euro terms.
The investor purchased two C EUR 150 options (each option protects €50,000) for the month of December. The price was $0.015/€1.
Each option gave him the right to purchase €50,000 at $1.50/€1. The total premium per option is: The total cost of the two option is therefore $1,500. If the dollar reaches $1.60/€1 by December 31, 2008, then the investor will have $167,500 at that time, which is equivalent to €104,688.
In this case, the investor not only maintains the value of his money, but he also earns on it. Of course, if the dollar-euro exchange rate falls, or remains at $1.50/€1.,then the investor loses money ( since he paid $1,500 for the options).
Calculating the profit on the option
Price of the underlying asset