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Hello sir,
I understand why is there is no “basis risk” in currency options but I have a question..
If I need to buy $2million (I’m in UK for example) in 3 months time, and there is a 4months expiry call option (in $), I’ll buy it and we don’t do any basis calculation as they are not linked with futures..
But how will I be able to buy $2million in 3months if the option expiry date is in 4 months?
Are currency options “American” options? (The text clearly mentions they are normally European options) If so, then how would we be able to buy it in 3months?
Hope you got my questionI have no idea which text you are referring to, or in what context it was written.
As far as exam questions on foreign currency options are concerned it is usually irrelevant as to whether they are American or European style options (unless, of course, they are OTC options in which case the distinction does not apply anyway).
In practice, if they are European style (in which case they can only be exercised on the due date) then if the transaction occurs before the due date then because the options are traded, instead of exercising them (which is not possible) they can be sold on to someone else if that were to be profitable which would end up having the same effect.
The distinction between European and American style options is only really relevant for calculations in the exam when asked to calculate the price of share options (using the BSOP model) because the formula provided only applies to European style options. (The formula for American style options is more complicated but is not examinable). However you cannot be asked to price foreign currency options.
Have you actually watched my free lectures on foreign exchange risk management, because I do explain all of this in my lectures?
I get it what you said sir..
But I was just thinking that if I needed the foreign currency in 3months and the option expiry date is in 4 months sayIn the exam we just calculate the cost under the option assuming it is exercised
But from a practical point of view, the option isn’t exercisable at the transaction date ( as you said), so what we do in exam, it doesn’t make any sense right?I’m just asking for my knowledge purpose. Sorry if I’m going the wrong way
Thank youIt is not a problem that can occur in the exam.
In practice it can occur and then it is as I wrote in my previous reply.
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