Expert take: Why currency options make for good investment

The world has gotten global. Your fortune sitting in India can change when there has been an interest rate hike or an inflation scare in another country because our currency has changed its value. Corporates, SMEs, all of them have exposure to foreign exchange and they want to hedge it. Traders and retailers have all gotten savvy and they have a view on the market. They want to play but how does one go about it?

Here is a quick heads-up on what currency options are:

An option contract is defined as a right but not an obligation to buy or sell an underlying asset at a pre-determined price at a specified time.

Main advantages:

• Upside unlimited
• Downside limited

For example, a buyer and a seller enter into specified contract. The contract is to buy USD INR at Rs 47. This is the strike price. The contract expiration will be by end of the month and contract size USD 1,000. The buyer pays the seller an option premium of Rs 0.33 per dollar, which is paid upfront.

At expiration:

Case one: If the price moves to Rs 48.5, the buyer benefits since spot is more than the strike. He makes Rs 1.5 on the contract. His net payoff stands at Rs 1.5 that he made on the contract minus 0.33 he spent to buy the option. The net profit stands at 1.17 per dollar and for the entire contract it would stand at Rs 1,170.

Case two: USD INR falls to Rs 46.5. In this case the buyer loses since the spot is lower than the strike. Such a case you let the contract expire and the buyer