Suppose you will receive US$100 million in three months and you would like to exchange the money to CAD. What option strategies can you use to guarantee an exchange rate between 1.2 and 1.3?
Option strategy to hedge currency risk would be to buy an option in the currency futures contract i.e. buy a CAD currency futures contract to sell 1 USD for 1.3 CAD with exercise date in 3 months.
This option gives a right to buy CAD currency contract but not an obligation i.e
Scenario 1 - if after 3 months, 1 USD = 1.3 or >1.3 CAD option holder can exchange USD to CAD at spot rate and only loss will be in terms of money spent to buy the option, which is usually say less than .1 CAD per unit i.e. effective exchange rate locked in will be between 1.2 to 1.3 CAD
Scenario 2 - Again, if at the end of 3 month 1 USD =less than 1.3 CAD, option holder can exercise the option and convert USD to CAD at 1.3 CAD per USD. Again the effective exchange rate accounting for transaction cost for option will be around 1.2 to 1.3 CAD per USD.
Get Answers For Free
Most questions answered within 1 hours.