Hedging with Foreign Currency Options
Chapters in this video
- 0:00 Currency exchange rate risk and the Nasdaq PHLX listing
- 1:25 Contract sizes: 10,000 units and the yen 1,000,000 exception
- 2:12 Physical settlement versus cash settlement
- 2:47 Cash-settled payoff calculation with euros
- 3:25 The golden rule: receive equals puts, pay equals calls
- 4:37 Exporter scenario: 500,000 euro put hedge
- 5:40 Importer scenario: 200,000 pound call hedge
- 6:21 Full hedge versus partial hedge distinction
- 7:10 Rapid-fire exam recap
What this video covers
- The standard foreign currency option contract size of 10,000 units and the Japanese yen exception at 1,000,000 units
- Physical settlement as the standard convention for currency options, and how cash settlement differs from index and yield-based options
- Calculating the payoff for a cash-settled currency option using the settlement-value-minus-strike difference multiplied by the contract size
- Applying the core hedging rule: receive equals puts, pay equals calls, for exporters, importers, and investors holding foreign securities
- Sizing the correct number of contracts for a currency hedge by dividing the foreign currency exposure by the contract size
- The distinction between a full hedge (buying an option, maximum protection at premium cost) and a partial hedge (selling an option, protection limited to premium received)
- Why a currency option expiring worthless is actually the best case scenario for the hedger
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