Читать книгу FX Option Performance - Peter Billington - Страница 8

Before we discuss which market participants can use this information, we should define more precisely what kind of contract we are talking about. Foreign Exchange (FX) options are contracts whose payoff depends upon the values of FX rates, and they are widely used financial instruments.

Let's look at a definition from a popular website…6

A foreign-exchange option is a derivative financial instrument that gives the owner the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified future date.

The price or cost of this right is called the premium, by analogy with the insurance market, and it is usually (depending on the tenor and the market at the time) a few percent of the insured amount (notional amount). The specified future date is called the expiry or expiry date.7 The payoff profile at expiry of the simplest type of option is shown schematically in Figure 1.1.

FIGURE 1.1 Payoff profile at expiry for a call option

The figure shows the payoff received by the holder of an at-the-money-forward (ATMF) call option on an FX rate. This means that the strike of the option is the forward rate, and the option is the right to buy the base currency, or, in other words, an option to buy the FX rate.8 In other markets such as commodities and equities it is obvious what the call or put is applied to but in FX more clarity is needed. For instance a call option associated with the currency pair USDJPY could be a call on USD (and thereby a put on JPY) or a call on JPY (and therefore a put on USD). As different currency pairs have different conventions it is always best to clarify the exact details before trading. A put option would be the right to sell the base currency, or FX rate. We will discuss forward rates and their relationship with options more completely in later chapters but in essence the forward rate is the current FX rate adjusted for interest rate effects. If the interest rates for the period of the option were identical in both currencies involved in the FX rate, then the forward rate would be identical to today's FX rate. Because they usually are not the same, the rate which one may lock in an exchange without risk for a future date will be somewhat different from today's rate.

The figure shows the premium cost of the option. At all FX rates at expiry which are less than the forward rate, this will be what the option holder loses, meaning that he or she paid a premium to buy the option and will make no money from it. The net result is the loss of the premium. At the forward rate, the payoff begins to rise, at first reducing the overall cost and then taking the owner of the option into profitable territory for higher FX rates at expiry. We have also shown the payoff from a forward contract, which is simply when the owner of the contract locks in the forward rate at the expiry date. This will lose money when the rate at expiry is less than the forward, and make money when the rate is higher. The forward rate is costless to lock in other than bid-offer costs.

The essential thing to grasp about the payoff to an option contract is that it is asymmetric. There is limited loss (the owner of the option can only lose the premium) but in theory unlimited gain. Conversely, the seller of the option stands to make a limited gain but an unlimited loss. Thus the option payoff looks very much like that of an insurance contract: we expect to pay a fixed premium to cover a variety of different loss types, up to and including very large losses indeed.

The difference between FX options and the more familiar types of insurance such as for a house or car is that, with the latter, we are pretty sure that we are paying more than we really need to. After all, in addition to covering losses, the insurance companies are paying their staff salaries, taxes and business costs. With FX options, we would anticipate that the bid-offer costs or trading activity cover the desk and business costs as a market-making desk makes money from buying and selling options, unlike an insurance company, which can only sell. We would expect the premium to add relatively little to the costs of the option; that the average cost of an option is close to the average payoff for the same option. If it is not (and in many cases we can show that it is not, at least on a historical basis) then there will be a number of interested parties. See the Appendix for more detail on what an option ‘should’ cost.