Hedging with Foreign Currency Options
Chapters in this video
- 0:00 Meet Carla and currency exchange rate risk
- 1:16 Physical settlement and PHLX listing
- 2:06 Contract sizes: 10,000 units and the yen exception
- 2:57 Receive puts, pay calls: the golden rule
- 4:36 Full hedge vs partial hedge: buying vs selling
- 5:22 Dog wig exporter and haunted clock importer math
- 7:06 Rapid-fire exam recap
What this video covers
- Why foreign currency options are physically settled (actual currency delivery), unlike index options that are cash settled
- The standard contract size of 10,000 units for most currencies, and the Japanese yen exception at 1,000,000 units per contract
- The golden rule for hedging: receive equals puts, pay equals calls, and how to apply it to U.S. exporters and importers
- Why an investor holding foreign securities has the same currency exposure as an exporter, and hedges with puts
- The difference between a full hedge (buying options) and a partial hedge (selling options) equal to the premium received
- How to size a hedge by dividing total currency exposure by the contract size (10,000 or 1,000,000 for yen)
- Why an option expiring worthless is the best-case scenario for a hedger, since the underlying business benefited from the favorable currency move
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