Question

Explain how firms can use currency option spread strategies to lower their costs of hedging.

Answer 1

Option spread strategy- It is a hedging strategy, used by firms to mitigate the losses or risk. This strategy involves simultaneously buying and selling the options of a same underlying but different strike price. This strategy is done with the help of call and put options. This is a most cost effective strategy. There are mainly three types of spread strategies:

1. Bull Spread
2. Bear Spread
3. Time Spread

Cost effective- These strategies are cost effective and minimize the trading cost because one option is bought so the premium is paid but simultaneously another option is sold and premium is received so it has very minimum cost. So when currency option spread strategies are used, one option is bought and another is sold so this is a low risk and low cost strategy.