Posted by forex at 4:39 AM
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Forex Options
1.
Exporting furniture to Canada
Protect your exposure--imagine you are the treasurer of an American company that sells furniture to Canada and you want to protect your exposure to a decline in the value of your Canadian dollar receivables.You have budgeted an exchange rate of USD/CA$1.0500 but the Canadian dollar is expected to weaken. You expect to receive CA$10 million at a dollar value of $9,523,809 (CA$10,000,000 divided by USD/CA$1.0500 = $9,523,809) in six months' time.
2. Call your bank and request from your banker a Canadian dollar European style put option (US dollar call option) expiring in 6 months time at a strike price of USD/CA$1.0500. This will give you the right but not the obligation to sell Canadian dollars at a strike price of USD/CA$1.0500. The banker informs you that you will need 953 lots at $10,000 a lot and the premium will be CA$0.02 cents per $1. (0.02 x 953 x 10,000 = CA$190,600 divided by USD/CA$1.0500 = USD $181,523 premium to be paid.
3. Buy the put option at the USD/CA$1.0500 strike price and pay the premium of $181,523. The premium you have paid reduces your company's effective selling rate for the Canadian dollars by 1.90 percent. ($181,523/$9,523,809 x 100 = 1.90 percent).
4. Calculate the effective exchange rate that has been reduced by the 1.90 percent premium you paid. USD/CA$1.0500 x 0.0190 percent = 0199 pips.Take away the 0199 pips from the strike price USD/$CA$1.0500 minus 0199 pips equals an exchange rate of USD/CA$1.0301. So now you know that the Canadian dollar needs to appreciate to below USD/CA$1.0301 to yield enough dollars to cover the premium paid. CA$10,000,000/budgeted rate USD/CA$1.0500 = $9,523,809 plus premium $181,523 = $9,705,332
5. Sell at the option strike price--imagine this scenario: six months have passed and the Canadian dollar has weakened to USD/CA$1.0700. Calculate how many dollars you would receive if you sold at that price. (CA$10,000,000 divided by USD/CA$1.0700 = $9,345,794). You calculate that if you sell Canadian dollars at that price you will receive $178,015 less than if you sold them at the option strike price of USD/CA$1.0500. You wisely decide to exercise your option and sell Canadian dollars at the strike price of USD/CA$1.0500 realizing your budgeted amount of $9,523,809.
6.
Fully hedged
Sell when the option expires--imagine another scenario: this time six months have passed and the Canadian dollar has unexpectedly strengthened to USD/CA$1.0280.You calculate that selling Canadian dollars at USD/CA$1.0280 yields you $9,727,626. You therefore allow the option to expire and you sell your Canadian dollars in the market at USD/CA$1.0280 giving you an overall profit of $22,294. ($9,727,626 less $9,523,809 which is the budgeted rate of USD/CA$1.0500 less the premium paid of $181,523).