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Hi, I find it’s difficult to understand the option hedging. Would someone explain the following questions for me?
1. Say it’s Dec 1, I want to borrow $100 two month later(Feb 1 next year) and pay back on May 31 (total period is 4 months). The interest rate is keeping growing, so I want to by options (the options is sold at $10 per contract on market). So what kind of options do I need (Dec or March)? and how much?
I see some questions are solved like this: 100/10=10 contracts
and somes like this: 100/10*(4/3)=13 contracts
2. If I need to pay in Euro, 100Euro on Feb 1. and I want to make currency hedging with currency option. The contract size is also 10Euro. What kind of options do I need (Dec or March)? and how much?
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one more question, If I want to use futrue contract in these two questions, and the contract size is also 10 in each currency. How much contracts do I need?
You need March options. The reason is that you will be wanting to close the deal on 1 February. December options are only valid until the end of December, so you want March options which are valid until the end of March.
You will buy 13 contracts. The reason is that you need to protect yourself against 4 months worth of interest change. The options are options to deal in futures where the gains are calculated as though 3 months interest. The make the two ‘equal’ you need to have the number of contracts as 100/10×4/3
The same answer applies to the second part of your question as well.
If you were using futures, then the number of contracts would be exactly the same, for the same reasons as above.
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So do you mean I should always buy the option or contract jast after the commencing day of the loan or currency translation?
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