Question

An Italian importer will be paid $1 million in three months (March). He must decide whether to sell $1 million forward or to buy currency options for that amount. The current market prices are as follows:

Exchange rates: Spot $/€ ? 1.10 Three-month forward: $/€ ? 1.11 Call euro March 110 U.S. cents: 1.5 U.S. cents per €. Put euro March 110 U.S. cents: 1.0 U.S. cents per €.

What are the differences between the strategies of selling currency forward and buying currency options?

Answer 1

Selling currency forward is profitable when the currency depreciates..For each move in currency, the profit changes by 1..The risk is unlimited and profit is unlimited.

Buying call option is profitable when the currency appreciates..For each move in currency, the profit does not change by 1 rather lesser than or equal 1..The risk is limited to the premium paid and profit is unlimited.

Buying put option is profitable when the currency depreciates..For each move in currency, the profit does not change by 1 rather lesser than or equal 1..The risk is limited to the premium paid and profit is unlimited.

In option, there is leverage beneift but in forwards one cannot get leverage benefit as in case of options, one is able to take larger exposure for the same amount used for forwards.