Table of Contents:

Options

Foreign exchange Options gives you the right to purchase / sell a currency at a certain price (from now, up till an expiration date). You have the right to purchase (or sell), but you dont have to. On the other hand, the other party to this "options" contract is required to buy (or sell) if you ask them to. These "options" can be bought and sold in a market (much like the "futures" can).

• Examples: If you expect to make a payment in the next 3 months, then you might want to purchase a "call option", which will give you the right to buy foreign currency (for you to make your payment) at a specified price. This way, you will be protected if the currency FX rate suddenly changes. At least you will be able to purchase the foreign currency at that price, and to make your payment as needed.

• If, on the other hand, you are waiting for a foreign currency payment to arrive, and you are afraid that a sudden change in the FX rate might decrease the amount of money you will receive, you might want to purchase a "put option" which will give you the right to sell the foreign currency at a certain price (over the specified time period).

Risk?

The stadard way to measure risk is by looking at volatility. The higher the volatility, the higher the standard deviation of expected returns.  Because returns are less certain, the level of risk is higher.

On the other hand, investments in options becomes more valuable as volatility rises. Why?  because there is a greater chance that (due to the higher volatility), you might be "in the money".  

Reducing Risk:  look at our discussion on hedging

How investing in "Options" works:

• pay now, can use option on 3rd wednesday of each quarter (March, June, etc)
• Premiums are traded on market, so premium price will change
• where with a forward / future...you are obligated to execute the contract at the end,
• but, with an option...you have the premium which gives you teh right to throw away the contract if you wish.

Trading Options (help):

• first recommendation is always a free website, www.optionseducation.org. This site should be the first stop for investors who want to learn about options. The website is funded by options exchanges so you can trust the information. The site has information about basic strategies, and registration lets you access webcasts and trading seminars. There's even a chatline.

Four simple choices

you can...

1. buy an option to buy
2. buy an option to sell
3. sell an option to buy
4. sell an option to sell

Hedging strategies using options:

see more in our discussion about hedging

learn more here:  http://www.amex.com/?href=/options/eductn/index_education.html

Risk Management

 When dealing with foreign exchange risk, you have a few choices as a business manager

1. Operationally hedge - balance your assets and liabilities so that currency is generated in revenues in the same country where liabilities are owed.   Another way to operationally hedge is to have operations in multiple countries, so that if one currency goes down, another will go up, etc.
2. Avoid - you can try to avoid currency risk by passing along the risk premium to your customers.  You can charge a risk premium, say for example 7% extra to all clients, and keep a fund ready for incase the currencies change, and then, that way...you will have money ready.  Its not a very good method, but some companies do it.
3. Protect yourself - hedge - transfer the risk to someone else that is more willing / able to take on that risk... if there is someone that is willing to take on risk for a fee, then sell them that risk, and take the money now.  This is the essence of currency hedging . 

• The four main choices for currency hedging are
  • (a) forward contracts  (see forward exchange rate)
  • (b) futures contracts  (see Futures market)
  • (c) options (see Options)
  • (d) use the money market to hedge
  • (d) sell your A/R to someone else  ....companies that buy your receivables at a discount.
    1. Bankers Acceptance -
       • is an agreement between an importer and exporter,
       • with payment in 30 days
       • cover goods in transit
       • irrevocable letter of credit (L/C) = confirmation + insurance + Bill of Lading (BL)
       • Then, if you have the irrevocable L/C...then you can get the "Bankers Acceptance
       • you sell the package of contracts
       • go to bank
       • sell those receivables at a discount...to get money today.
    2. factoring
       • might buy next 15 shipments
       • multiple shipments
       • but, because there is no guarantee, then the banks charge a higher commission
       • get money today
    3. forefeiting
       • committment by a country (government)
       • host country guarantee
       • popular in older times, and in Middle east.

Options & VC finance

see our discussion on real options

Links from KookyPlan: 

foreign currency trading

spot exchange rate

forward exchange rate

foreign exchange Swaps

Futures market

Currency

appreciation

depreciation

Discount

Premium

Look up prices on Yahoo finance

http://finance.yahoo.com/q/op?s=GE

View By Expiration: Dec 07 | Jan 08 | Mar 08 | Jun 08 | Jan 09 | Jan 10

Strike Symbol Last Chg Bid Ask Vol Open Int 22.50 GELX.X 15.75 0.00 14.15 14.30 114 909 25.00 GELE.X 12.20 0.05 11.65 11.80 14 575 27.50 GELY.X 9.70 0.00 9.10 9.20 72 858 30.00 GELF.X 7.70 0.00 6.70 6.80 2 1,391 32.50 GELZ.X 4.40 0.75 4.30 4.45 664 3,718 35.00 GELG.X 2.22 0.88 2.21 2.28 1,183 11,481 37.50 GELS.X 0.75 0.53 0.73 0.77 5,914 34,823 40.00 GELH.X 0.14 0.13 0.14 0.15 1,887 145,673 42.50 GELV.X 0.03 0.00 0.02 0.03 309 54,770 45.00 GELI.X 0.02 0.00 N/A 0.02 1 26,226 47.50 GELW.X 0.02 0.00 N/A 0.02 100 4,555

Strike Symbol Last Chg Bid Ask Vol Open Int 22.50 GEXX.X 0.08 0.00 N/A 0.02 84 84 25.00 GEXE.X 0.02 0.00 N/A 0.02 10 848 27.50 GEXY.X 0.05 0.00 N/A 0.03 12 396 30.00 GEXF.X 0.04 0.00 0.03 0.05 173 5,467 32.50 GEXZ.X 0.16 0.05 0.14 0.16 246 9,122 35.00 GEXG.X 0.52 0.20 0.53 0.55 1,706 52,558 37.50 GEXS.X 1.60 0.65 1.54 1.58 3,561 56,316 40.00 GEXH.X 3.30 0.78 3.40 3.50 723 66,418 42.50 GEXV.X 5.45 0.06 5.80 5.95 22 35,781 45.00 GEXI.X 7.55 0.15 8.30 8.45 5 473 50.00 GEXJ.X 12.20 0.00 13.30 13.45 70 14 55.00 GEXK.X 17.20 0.00 18.30 18.45 70 17

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