A US investor has purchased Sterling Treasury bills and wishes to hedge against the falling value of Sterling. Buying the out-of-the-money put (strike price $1.8500) will protect against a fall below that figure. The sale of the out-of-the-money call at $1.8900 will mean that the investor will benefit from any rise in Sterling to $1.8900 but not above that figure. The cost of buying the put is off-set by the revenue from writing the call, resulting in this instance in a zero cost strategy.

The reader will note that if Sterling rises above $1.8900, the written call position will make a loss. This is off-set by the rising value in dollar terms of the underlying Sterling investment. Conversely, if Sterling falls below $1.8850, the puts make a profit which off-sets the currency losses on the investment in the Sterling Treasury bills. Read more »

Posted: June 22nd, 2008 under Commodities Futures, Currency Futures, Equity Futures, Future Fund, Futures Contracts, Futures Options, Futures Spreads, Futures Trader, Futures Trading System, Managed Futures, S&P Futures.
Comments: 4

This section explains two of the many uses of options that rely upon the ability of the option buyer to abandon the option at no extra cost. The first is the purchase of options to insure against a fall in the value of a currency. The second is the hedging of the currency risk in a foreign currency tender.

Purchasing options as a form of insurance

If a US investment manager has strong expectations of a rise in the value of Sterling but wishes to insure against being totally wrong, slightly out-of-the money puts will provide the required insurance. Read more »

Posted: June 21st, 2008 under Commodities Futures, Equity Futures, Foreign Exchange Futures, Future Fund, Future Investing, Futures Options, Futures Prices, Futures Spreads, Futures Trading System, Managed Futures, Stock Futures, Stock Market Futures.
Comments: 5

Average rate currency options are based upon the average exchange rate of the underlying currency as distinct from the exchange rate on a single date — the expiry date.

The advantage of an average rate option is that the volatility of a moving average of a variable is less than the volatility of individual observations of that same variable. With daily observations, and with the volatility levels seen in the currency markets, the volatility of the moving average is in the order of 60% of that of the raw observations. Consequently, the price of an average rate option with a given exercise price will be less than an otherwise identical standard European currency option. Read more »

Posted: June 21st, 2008 under Equity Futures, Future Market Trends, Futures Market, Futures Options, Futures Spreads, S&P Futures, Stock Market Futures, Swap Futures, investment.
Comments: 5

The valuation of interest rate options is currently the most contested area of option- pricing theory. The problem stems from the fact that although there is a reasonable consensus about the nature of the stochastic process of share prices, equity indices and currencies, the movements in interest rates and interest rate dependent instruments are not fully understood and full agreement on the underlying process has yet to be reached.

The stochastic process of interest rates, and therefore the prices of interest rate dependent claims, has proved to be very difficult to model for a number of reasons. Read more »

Posted: June 17th, 2008 under Equity Futures, Future Broker, Futures Contracts, Futures Quotes, Managed Futures, Stock Market Futures, Swap Futures.
Comments: 4

Currency swaps, which were developed before interest rate swaps, were derivations of the 1970s practice of establishing parallel loans between two parties whereby, for example, company A would lend its domestic currency to company B, in return for a loan of company B’s domestic currency. These parallel loans were often used to manage exchange risk or to circumvent exchange control regulations.

This system of mutual lending had two serious drawbacks. First, there was no automatic off-set of the cash flows between parties. Thus, if company A defaulted on its loan from B, company B would still have to honour its commitment to A. Secondly, although the two loans effectively cancelled each other out, they were still shown on the balance sheets of each company. Read more »

Posted: June 14th, 2008 under Commodities Futures, Crude Oil Futures, Equity Futures, Future Exchange, Future Fund, Future Investing, Future Management, Future Trading, Futures Contracts, Managed Futures, Swap Futures.
Comments: 3