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Chap 7: Futures and Options on Foreign Exchange - Coggle Diagram
Chap 7: Futures and Options on
Foreign Exchange
Futures Contracts: Some Preliminaries
Standardizing Features:
Contract Size
specifying the amount of the underlying foreign currency
future purchase
sale
the maturity date of the contract
Futures contracts have specific delivery months during the year
contracts mature on a specified day of the month
settled-up
marked-to-market (revalued)
daily at the settlement price
The settlement price
a price representative
futures transaction prices at the close of daily trading on the exchange
A buyer of a futures contract (one who holds a long position)
1 more item...
A futures contract
like a forward contract
certain currency
will be exchanged for another at a specified time
in the future at prices specified today
different from a forward contract:
Futures are standardized contracts trading
organized exchanges with daily resettlement through a clearinghouse
written for a specific amount of foreign currency
Two types of market participants
speculators
attempts to profit from a change
in the futures price
will take a long or short position in a futures
contract
depending upon his expectations of
future price movement
hedgers
wants to avoid price variation
locking in a purchase price of the underlying
asset through a long position
in the futures contract or a sales price through a short position
Initial performance bond (formally called margin)
deposited into a collateral account to establish a futures position
The initial performance bond
generally equal to about 2 percent of the contract value
cash or T- bills held in a street name at your brokerage
Differences between Futures and
Forward contracts
Futures
Trading location
Traded competitively on organized exchanges.
Contractual Size
Standardized amount of the underlying asset.
Settlement
Daily settlement, or marking-to-
market,
done by the futures clearinghouse through the participant’s performance bond account.
Expiration Date
Standardized delivery dates.
Delivery
Delivery of the underlying asset is
seldom made.
a reversing trade is transacted to exit the market.
Trading Costs
Bid-ask spread plus broker’s commission.
Forward
Trading location
Traded by bank dealers via a
network of telephones
computerized dealing systems.
Contractual Size
Tailor-made to the needs of the
participant.
Settlement
Participant buys or sells the contractual amount of the underlying asset
from the bank at maturity at the forward (contractual) price.
Expiration Date
Tailor-made delivery date that
meets the needs of the investor.
Delivery
Delivery of the underlying asset is
commonly made.
Trading Costs
Bid-ask spread plus indirect bank charges via compensating balance requirements.
Currency Futures Markets
The Chicago Mercantile Exchange
(CME, from 1972)
the largest.
Expiry cycle:
in a March, June, September, and December
Delivery date:
the third Wednesday of the expiration month.
The last day of trading
is the second business day prior to the delivery date.
Trading in CME currency futures contracts takes place Sunday through Friday on the GLOBEX
trading system from 5:00 p.m. to 4:00 p.m. Chicago time the next day.
GLOBEX is a worldwide automated order-entry
matching system for futures and options that provides nearly 24-hour trading.
Others
The Intercontinental Exchange (ICE) Futures U.S. (formerly the New York Board of Trade)
The Mexican Derivatives Exchange
The BM&F Exchange in Brazil
The Budapest Commodity Exchange
The Derivatives Market Division of the Korean Exchange
Basic Currency Futures Relationships
Open Interest
number of contracts outstanding for a particular delivery month.
good proxy for demand for a contract.
depth of the market.
breadth of the market would be
how many different contracts are outstanding.
IRP model
Options Contracts: Some Preliminaries
Option
Calls & Puts
the right, but not the obligation, to buy or sell a
given quantity of an asset in the future, at prices agreed upon today.
Call
buy a given quantity of
some asset
Put
sell a given quantity of
some asset
Glossary of terms
buyer or holder.
investor buying
writer or seller.
investor selling
exercising the option.
decides to buy (sell) the asset
underlying asset.
asset to be bought or sold
pay a premium
option to buy or sell
exercise price or
strike price.
price agreed upon for buying or selling
options exchanges.
Options are traded
open interest.
number of outstanding option contracts at any time
European vs. American
options
European options
exercised on the expiration
date.
American options
exercised at any time up to and including the expiration date.
Currency Options Markets
Are an option on a currency futures contract.
Exercise of a currency futures option results in a long futures position for the holder of a call or the writer of a put.
Exercise of a currency futures option results in a short futures position for the seller of a call or the buyer of a put.
If the futures position is not offset prior to its expiration, foreign currency will change hands
Basic Option-Pricing Relationships at Expiration
Basic Option-Pricing Relationships at Expiration
an American call option is worth the same as a European option with the samecharacteristics.
CaT = CeT = Max[ST- E, 0] (7.2)
out-of-the-money
ST < E (E < ST)
in-the money
ST > E (E > ST)
at-the-money
ST = E
Example
EUR Call Option: Writer’s Perspective
a European put and an American put will have the same value.
PaT = PeT = Max[E - ST, 0]
EUR Call Option: Buyer’s Perspective
European Option-Pricing Relationships
The pricing boundaries for European
put and call premiums
more complex
can only be exercised at expiration
Example
:fire:
the lower boundary expression for a European call.
the European call can never sell for a negative amount
Ce + E /(1 + r$) ≥ St/(1 + ri)
The larger (smaller) is St
The smaller (larger) is E,
The smaller (larger) is ri
The larger (smaller) is r$ and,
The larger (smaller) r$ is relative to ri
the lower boundary pricing relationship for a European put
IRP
implies FT = St[(1 + r$)/(1 + ri)]
European call and put prices on spot foreign exchange
American Option-Pricing Relationships
European option AND
exercise prior
Pat > Pet = Max[E - St, 0] (7.5)
where P denotes the value of the put at expiration
Cat > Cet = Max[St- E, 0] (7.4)
Time value, Market Value and Intrinsic Value
Time value
difference
the option premium
nonnegative
the option’s intrinsic value
