7/21/2019 Understanding Forwards & Options http://slidepdf.com/reader/full/understanding-forwards-options 1/39 UNDERSTANDING UNDERSTANDING FORWARDS& FORWARDS& OPTIONS OPTIONS
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 1/39
UNDERSTANDINGUNDERSTANDING
FORWARDS &FORWARDS &
OPTIONSOPTIONS
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 2/39
Contract to sell or buy a currency at a rate agreed
today; for delivery at a pre-determined future date or
time period Difference between the spot and the forward rate is
called, forward points, swap points, or forward
margin. Outright forward rate = spot rate + forward points
Forward Contracts
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 3/39
Interest Parity Principle
etween two freely convertible currencies, the difference between the spot rate and the forward rate is determined by
the interest rate differential between the two currencies.
!pot " # $uro = #.%%%& '!D
( month )nterest *ates " '!D #. ; $'* #.((
(m Forward 1 Euro = 1. 3339 USD
!pot *ate )nterest *ate Differential /orward 0eriod
#11 2o. of days in the year 3or4 5onths in a 6ear
= #.%%%&3#.-#.((4( / #11#
= 1.1117
=
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 4/39
Interest Parity Principle....
orrow # $'* at #.(& )nt. payable 1.118%
!ell # $'* against #.%%%& '!D !pot)nvest #.%%%& '!D at #. )nt. receivable 1.1##7(
9o eliminate arbitrage today:s (m forward should be such that
'!D #.%77( = $uro #.118%
# $uro = 3#.%77(<#.118%4 = '!D #.%%%
To erify
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 5/39
Interest Parity Principle….
Currency with low interest rate will be at a premium
Currency with high interest rate will be at a discount
/orward rate is no indication of future spot rate
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 6/39
Calculation of Annualised Premiums
!pot <*e = *s. &1.%&
(5 - /wd.0remium = *s 1.(8
>nnuali?ed 0remium " 0remium #11 %(& !pot n
1.(8 #11 %(&
&1.%& #81
*esult " .%
n = 0remium period in days
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 7/39
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 8/39
Option Forwards (Time Options)
'!D )mports for @uly nd half
'!D<)2* = &1.% + 1.7%11 + anA:s 5argin
0remium charged up to %#<1<1
'!D $Bports for @uly nd half 3they will get only till #&th
@ul4'!D<)2* = &1.%& - 1.%%8 - anA:s 5argin
0remium provided up to #&<1&<1 = 1.%711 + 31.7#11-1.%7114 #&<%#
3>2 )! 9$ E)22$* )2 O9 9$ C>!$!4
!pot *ate &1.%& &1.%
%1 >pril 1.#1 1.#
%# 5ay 1.(
%1 @une 1.%7 1.%(
%# @uly 1.7# 1.7%
1.7
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 9/39
Cancellation
F On #st /eb-1, an eBporter sold #11111 for %1th @un 1
delivery G &1.&
! "ontract cancelled # mont$s before maturity
On %1<17, with the month forward rate from cancellation dateto %1th @un at say &#.11 the cancellation loss of *s.3&1114 i.e
3&#.11-&1.&4#11,1114 will be recovered from the customer.
!! %utomatic cancellation on t$e &t$ day from t$edate of maturity H)f a gain is made on cancellation, the gain
will not be passed on to the customer but the loss will of course
be recovered.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 10/39
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 11/39
Excan!e Control aspects
9he customer can be given the facility of booAing a single
forward contract for several orders provided that the receivables are
in the same currency and the liAely cash flow period falls within the
same contract period.
$Bporters are allowed to deliver eBchange representing a portion
of the eBport value in part utilisation of the forward contract.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 12/39
Managing
Risk
Using Option
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 13/39
Option
- contract were te u'er as te ri4t ut not teoli4ation to
* 6u'/,ell* ,peci%ied uantit' o% a currenc'* -t a speci%ied price "strie price* 6' a particular date "expir' date
For tis ri4t te u'er pa's te seller"writer o% te
option an up%ront %ee "called option preiu
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 14/39
Option "#s Forward
9 :ption 4i;e te u'er ari4t ut no oli4ation.
9 <ood instruent toed4e ad;erse price
o;es a;oidin4opportunit' loss.
9 p%ront preiu
9Can coose te strieprice
9 ,peci%ic date
9 Forwards are %ixed pricecontracts werein teu'er/seller is oli4atedto te price
9 :pportunit' loss
9 1o up%ront preiu
9 Cannot coose testrie price
9 :ption %orwards "tieoptions
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 15/39
Two types of option
American Option
5ay be eBercised at any time during the life of a contract.
European Option.
5ay be eBercised only at maturity or eBpiry date.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 16/39
Option Terminolo!ies
Call Option
Jives the holder the right but not the obligation to
'U( an underlying at a fiBed price from the writer of
the option.
Put Option
Jives the holder the right but not the obligation to
SE)) an underlying at a fiBed price to the writer of
the option
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 17/39
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 18/39
%is& # Profit Profile
uyer Seller
!rofit Unli"ite# !re"iu"
Ris$ !re"iu" Unli"ite#
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 19/39
Option ' pecs
,trie ?rice or @xercise priceAe %ixed price at wic te option older as teri4t to u' or sell te underl'in4 currenc'.
@xpir' Date Ae last da' on wic te option a' e exercised.
Bi%e or @xercise ?eriodAe period o% tie durin4 wic te option oldereno's te purcased option contracts.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 20/39
Option stri&e price
n te one' "A
Ae option is n te one' wen te ,trie ?rice is %a;ouraleto te option older"u'er tan te current %orward rate.
@4 ,D put option wit strie 50.00 E current %wd rate #).20 Eoption in te one'
:ut o% te one' ":A Ae option is :ut o% te one' wen te ,trie ?rice isun%a;ourale to te option older"/u'er tan te current%orward rate.
@4 ,D put option wit strie #5.00 E current %wd rate #).20 E
option out o% te one' -t te one' "-A Ae option is -t te one' wen te ,trie ?rice is eual to
te current %orward rate.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 21/39
Price of an Option
Can te :ption u'er a;e te cae eat it too
1ot reall' * since te option seller car4es te u'er anup%ront preiu pa'ale in cas.
-nd te up%ront preiu can e as i4 as &G or e;en oredependin4 on te strie price and te aturit' period.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 22/39
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 23/39
0.0000
0.1000
0.000
0./000
0.4000
0.5000
0.000
0.7000
0.8000
0.9000
4.05 4.15 4.5 4./5 4.45 4.55 4.5 4.75 4.85 4.95 47.05 47.15
!re"iu"
Intrinsi% &alue
'i"e alue
Te Premium of a Put Option di"ided into Time
*alue + Intrinsic *alue
Spot USD/INR 2 4.053# USD/INR2 4.55
>s the striAe of the put 3B-aBis4 increases, the premium goes up. /or an out of money put,
there is only time Kalue and no intrinsic value. >s soon as the striAe goes above the forward
rate 3i.e. option becomes )954, time value starts to come down and intrinsic value goes up.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 24/39
Option premium $ ,uotations
0oints of the second currency<terms currency
or
0remiums are Luoted as a flat percentage of the base currency
principal amount
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 25/39
Factors determinin! Premium "alue
Holatilit'
,trie ?rice
Bi%e or @xercise ?eriod
nterest Rates * doestic %orei4n
Current aret Rate
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 26/39
0
0.005
0.0&
0.0&5
0.02
0.025
& 2 3 # 5 ! 7 8 ) &0
5 axis 6 &olatility in 7 8 axis 6 9ption !re"iu"
s
Can!e in premium wit can!e in "olatility
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 27/39
tri&e Price -ynamics
Ae option preiu can e uite i4 %or -A options.
s tere a wa' to reduce te preiu
There is one golden rule. You can’t get anything in the
market for free.
,o to reduce te preiu 'ou a;e to 4i;e up soeprotection.
Ao reduce te preiu 'ou a;e to raise te strie price
and consider u'in4 an :A option tere' 4i;in4 upsoe protection. Ae ore :A te option is te lowerwill e te preiu. Con;ersel' te ore A an optionis te i4er will e te preiu.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 28/39
Option trate!ies
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 29/39
PAI/ *A/IA OPTIO/
F $Bporter H uy a '!D 0ut< )2* Call at &#.1%
F Cost H *s. #.1 per
F 5aturity H %1th !eptember 11
F !pot H &1.%1 /orward *ate H &#.1%
$Bplanation " On maturity
if '!D<)2* M &#.1% , corporate sells '!D at &#.1%
if '!D<)2* N &#.1% , Corporate sells at spot
T$e ma*imum loss in t$is structure is t$e cost +aid for t$e
o+tion and is ,nown u+front and t$e -ains are unlimited
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 30/39
E0 "ST 2T! ST0%TE4!ES
-n option u'er can reduce is preiu cost ' sellin4
anoter option. Ae coination can reduce te cost aste preiu recei;ed on te option sold could eiterpartiall' or %ull' o%%set te cost o% option ou4t.
Different Strate:ies2
&. Ran4e Forward
2. Re;erse Ran4e
3. ?articipatin4 Forward
#. Be;era4ed
5. Be;era4ed
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 31/39
%A/0E FO%1A%-
Definition " uy a '!D put < )2* Call at 7.71
!ell a '!D Call<)2* 0ut at &.11
5aturity " %1th
!eptember 11
$Bplanation " On maturity
if '!D<)2* M 7.71 , corporate sells '!D at 7.71
if '!D<)2* N &.11 , Corporate forced to sell at &.11
)f '!D<)2* is between 7.71 and &.11, then the corporate
gets the spot.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 32/39
%E*E%E %A/0E
Definition " uy a '!D put < )2* Call at &.11
!ell a '!D Call<)2* 0ut at 7.&1
5aturity " %1th !eptember 11
$Bplanation " On maturity
if '!D<)2* M 7.&1, corporate sells '!D at &.11
if '!D<)2* N &.11 , Corporate forced to sell at 7.&1
)f '!D<)2* is between 7.&1 and &.11, then the corporate
sells at 7.&1+3&.11-!pot on maturity4P.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 33/39
PA%TICIPATI/0 FO%1A%-
Definition " uy a '!D put < )2* Call at 7.&1
!ell a 1.& '!D Call<)2* 0ut at 7.&1
5aturity " %1th
!eptember 11
$Bplanation " On maturity
if '!D<)2* M 7.&1 , corporate sells '!D at 7.&1
if '!D<)2* N 7.&1 , Corporate forced to sell half of the
eBposure at 7.&1 and the balance at the spot.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 34/39
E*E%A0E-
Definition " uy a '!D put < )2* Call at &#.&
!ell a '!D Call<)2* 0ut at &#.&
5aturity " %1th !eptember 11
$Bplanation " On maturity
if '!D<)2* M &#.& , corporate sells '!D at &#.&
if '!D<)2* N &#.& , Corporate forced to sell twice t$e
amount at &#.&
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 35/39
%upee Option ' Product specs
Hanilla @uropean options coinations tereo% atintroduction. Ais will continue till ans a;esopisticated s'stes ris ana4eent %raewors toed4e tis new non*linear product.
:;er te counter contracts.
Can e tailored to suit te corporateIs need.
1o iniu optional at recoended ' R6.
?reiu pa'ale on spot asis.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 36/39
%upee Option ' Product specs..
,ettleent would e eiter ' deli;er' on spot asis ornet cas settleent in Rupees on ,pot asis dependin4on te FC*1R spot rate on aturit' date. "specs will e
speci%ied in te contract E R6 re%erence rate could e tere%erence rate %or settleent.
,trie ?rice aturit' could e tailored to suit
counterpartiesI needs E t'pical aturities are & wee2wees & 2 3 ! ) &2 onts.
@xercise st'le @uropean.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 37/39
2ses of %upee option
Ao ed4e 4enuine FJ exposures arisin4 out o%trade/usiness "6ans a' oo transactions ased onestiated exposure %or uncertain aounts
Ao ed4e FC loans.
6alance in @@FC accounts.
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 38/39
7/21/2019 Understanding Forwards & Options
http://slidepdf.com/reader/full/understanding-forwards-options 39/39
9hanA 6ou