Presented by :-

D.Pradeep Kumar
Exe-MBA ,IIPM, Hyd
Forward Contract: It is a simple derivative that involves an agreement to
buy/sell an asset on a certain future date at an agreed price.

Future Contract: It is a standardized contract between two parties who do not

necessarily know each other and it is for performance by a clearing corporation
or clearing house.

Options Contract: It is a legal contract which gives the holder the right to
buy or sell a specified amount of underlying asset at a fixed price within a
specified period of time.The holder is not obliged to buy or sell the underlying
asset.

(A) CALL

(B) PUT
What is a Currency Option Contract?

“A financial agreement giving the buyer the right

(but not the obligation)
to buy/sell a specified amount of currency at a specified rate
on a specified date”

• 100% protection
• 100% participation
How does it compare to the Forward?

“A financial contract whereby the owner has the obligation

to buy/sell a specified amount of currency at a specified rate
on a specified date”

• 100% protection
• 0% participation
Definitions

• The right to buy a specified amount of

Call Option currency at a specified rate

Put Option • The right to sell a specified amount of

currency at a specified rate

Premium • The price of an option

• The rate at which the right can be exercised

Strike

• The date at which the right can be exercised

Expiry Date
 Types of Options

• OTC Options

European style
Option Option only exercisable on the expiry date

American style
Option Option exercisable at any time until expiry

• Listed Options Chicago IMM, Philadelphia

 American-Style option
• American-Style option An option contract
that may be exercised at any time between
the date of purchase and the expiration date.
Most exchange-traded options are
American-style. In India options on stocks
are American option.
 European-style options
• European-style options
An option contract that may be exercised
only during a specified period of time just
prior to its expiration. In India Index
options are European-style options.
 Options
Options are of two types – Calls & Puts
Call options give the buyer the right but not the obligation to buy a
given quantity of the underlying asset , at a given price on or before a
given future date.

Put options give the buyer the right , but not the obligation to sell a
given quantity of the underlying asset at a given price on or before a
given date.

Long=Buy= Holder
Short=Sell=Writer
C= Current Price of the Call
E=Exercise Price=Strike Price
So=The current price of the share
S1=The stock price at the expiration date of the call.
Terminology

Unlike futures and forward positions, you have to pay

for an option. The amount you pay is known as the
“Option Premium”

The “Intrinsic value” of an option is how much you

could get from exercising the option immediately. An
American option premium, of course, will always at
least as great as the option’s intrinsic value. The
different between the option premium and the
intrinsic value is known as the “Time Value”
Term – Cont’d

• An Option is “in-the-money” if its intrinsic value is

positive, and “out-of-the-money” otherwise. An at
the- money option is one with a strike price close to
the underlying asset price.
 Terminology
• Spot Price: The price at which an asset trades in the spot
market.
• Future Price : The price at which the futures contract trades
in the futures market.
• Option Price: Option price is the price which the option
buyer pays to the option seller.
• Exercise Price: The price specified in the options contract is
known as the strike price or the exercise price.
• Basis: Basis is usually defined as the spot price minus the
future price.
 Life of an option
• The life of an option is limited: it has an
expiration date. After the expiration date all
the rights and obligations conferred by the
option are null and void. The option holder
can exercise the option, i.e. declare he or
she wants to use the right to buy (or to sell)
conferred by the option.
Hedging

• Option can be used as investments, or to hedge

the downside risk of an existing foreign currency
exposure. In both cases, it is common to work with
“payoff diagram”, which show what is the terminal
payoff from holding a (European) option conditional
on where the spot exchange rate ends up. That
terminal payoff depends upon whether the spot
exchange rate ends up above or below the strike
price, and whether the option is a call or put.
Hedging – Cont’d

• Buying options can offset the downside foreign

currency risk of a position, while retaining the upside
potential – at a cost. Options are “insurance” against
bad realizations of the exchange rate.

• Buying call options ensures the right to acquire

foreign currency at a prespecified price (e.g., to pay
off a future liability), while allowing you to forego that
right if you can get a cheaper price in the spot
market.
Hedging – Cont’d

• Buying put options ensures the right to sell

foreign currency (future accounts receivable) at
a pre specified price, while allowing you to sell
at a higher price in the spot market if chance
permits.
 The Four Basic Option Payoffs

• Thus, the four basic option positions - buy a call, sell a call, buy
a put, sell a put - can be summarized using a diagram:

BUY BUY
PUT CALL

SELL SELL
PUT CALL

FX, Derivatives and DCM workop I

 Options Pricing

The premium of an option has two main components: INTRINSIC Value &
Time Value.

Intrinsic Value (Calls):

When the underlying security's price is higher than the strike price a call option
is said to be "in-the-money."

Intrinsic Value (Puts):

If the underlying security's price is less than the strike price, a put option is "in-
the-money." Only in-the-money options have intrinsic value, representing the
difference between the current price of the underlying security and the option's
exercise price, or strike price.
Time Value:

Prior to expiration, any premium in excess of intrinsic value is called

time value. Time value is also known as the amount an investor is
willing to pay for an option above its intrinsic value, in the hope that at
some time prior to expiration its value will increase because of a
favorable change in the price of the underlying security. The longer the
amount of time for market conditions to work to an investor's benefit, the
greater the time value.
Uses of Options
Hedgers can use options to reduce risk.
They can reduce the risk that a stock they own will decline by
buying put options on it.
Speculators can use options to gamble that prices will change.
They can buy a put option on a stock if they think it will go
down.
Arbitragers can use options to gain risk-less profits if
securities are inconsistently priced.
 Terminology
• Let S0=The Stock Price. E=Exercise Price.

• Condition Call Option Put option

• S0>E In-the-Money Out-of-the-Money

• S0<E Out-of-the-Money In-the-Money

• S0=E At-the-Money At-the-Money

In the Money Out of the Money
Market Price
Call Options Call Options

Strike Prices Calls Strike Prices

Puts
160 162 164 166 168 170 172

Out the Money In the Money Put

Put Options Options
 Options: Strategy

•An investor who expects a bull market

should buy a call option.
•An investor who expects a bear market
should buy a put option.
•The seller receives the premium but his risk
is unlimited.
•For this reason, the selling of options should
be considered only by experienced traders.
 Buy Sell
Bullish

Call Put

Put Call

Bearish
Thank you