Chapter7FuturesandOptionsonForeignExchangeFuturesContracts:SomePreliminariesCurrencyFuturesMarketsBasicCurrencyFuturesRelationshipsOptionsContracts:SomePreliminariesCurrencyOptionsMarketsCurrencyFuturesOptionsBasicOption-PricingRelationshipsatExpirationAmericanOption-PricingRelationshipsEuropeanOption-PricingRelationshipsBinomialOption-PricingModelEuropeanOption-PricingFormulaEmpiricalTestsofCurrencyOptionsSummaryThischapterintroducedcurrencyfuturesandoptionsonforeignexchange.Theseinstrumentsareusefulforspeculatingandhedgingforeignexchangeratemovements.Inlaterchapters,itwillbeshownhowtousethesevehiclesforhedgingpurposes.1.Forward,futures,andoptionscontractsarederivative,orcontingentclaim,securities.Thatis,theirvalueisderivedorcontingentuponthevalueoftheassetthatunder-liesthesesecurities.2.Forwardandfuturescontractsaresimilarinstruments,buttherearedifferences.Botharecontractstobuyorsellacertainquantityofaspecificunderlyingassetatsomespecificpriceinthefuture.Futurescontracts,however,areexchange-traded,andtherearestandardizedfeaturesthatdistinguishthemfromthetailor-madetermsofforwardcontracts.Thetwomainstandardizedfeaturesarecontractsizeandmaturitydate.3.Additionally,futurescontractsaremarked-to-marketonadailybasisatthenewsettlementprice.Hence,theperformancebondaccountofanindividualwithafuturespositionisincreasedordecreased,reflectingdailyrealizedprofitsorlossesresultingfromthechangeinthefuturessettlementpricefromthepreviousday’ssettlementprice.4.Afuturesmarketrequiresspeculatorsandhedgerstoeffectivelyoperate.Hedgersattempttoavoidtheriskofpricechangeoftheunderlyingasset,andspeculatorsattempttoprofitfromanticipatingthedirectionoffuturepricechanges.5.TheCMEGroupandtheNASDAQOMXFuturesExchangearethetwolargestcurrencyfuturesexchanges.6.ThepricingequationtypicallyusedtopricecurrencyfuturesistheIRPrelationship,whichisalsousedtopricecurrencyforwardcontracts.7.Anoptionistheright,butnottheobligation,tobuyorselltheunderlyingassetforastatedpriceoverastatedtimeperiod.Calloptionsgivetheownertherighttobuy,putoptionstherighttosell.Americanoptionscanbeexercisedatanytimeduringtheirlife;Europeanoptionscanonlybeexercisedatmaturity.8.Exchange-tradedoptionswithstandardizedfeaturesaretradedontwoexchanges.OptionsonspotforeignexchangearetradedattheNASDAQOMXPHLX,andoptionsoncurrencyfuturesaretradedattheCME.9.Basicboundaryexpressionsforputandcalloptionpricesweredevelopedandexaminedusingactualoption-pricingdata.10.AEuropeanoption-pricingmodelforputandcalloptionswasalsopresentedandexplainedusingactualmarketdata.
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