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Hi, I need help with deciding whether you should buy a put or call option especially if a non-US company is expecting to receive or pay USD and wants to hedge by purchasing options.
My textbook says there are no USD call or put options. However, I do not know how to deal with such a question.
So, the option is always defined with respect to the non-dollar currency.
If you are in the UK and are going to receive US$ from a customer, you want to buy £ so the option is a CALL option on £.
Don’t look at it from the US$ view.
Thank you, would you mind explaining the thought process i.e. If we buy GBP, what are we implying? Why do we buy pounds and what is going to happen when we actually receive the payment from the debtor. I hope I make sense.
I assume we are still talking about options?
If you buy a call option on £, you are buying the right to exchange $ for £ at a certain rate. You pay the option premium immediately. It’s like insuring your house against fire: the premium is paid when you take out the policy. You are not forced to claim under the insurance, of course, and would only do so if the house became fire-damaged, but whether you claim or not you will not get a refund on the premium.
Similarly with the currency option. You can exercise the option and insist that the counter-party gives you £ for $ at the agreed rate or you can simply ignore the option (let it lapse) and change the money at the going rate when you receive the $.
Hi dineo2,
Regarding your question to whether you should buy call or put option , the following are the steps to be followed:-
1) First assess what could be the exchange rate in future (whether foreign currency is depreciating or appreciating against home currency)
Ex: – You are a uk company and you are expecting to receive usd in future and If today the exchange rate is 1pound =1.32 usd and in future if you are expecting the exchange rate to be 1 pound = 1.5 usd dollar
Then by having call option ex :- 1 pound =1.4 usd , you can still purchase @1.4 though the market price is 1.5 usd dollar.
A call option gives the buyer the right to purchase the foreign currency at the rate which is other than the market rate.
If the strike price rate is more than the market price rate, then lapse the option
If the strike price rate is less than the market price, then avail the optionHope this gives clarity on your doubt.
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