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The scenario of the execution of a currency option with a deposit coverage. Currency option with deposit coverage: features, conditions

In the previous chapter, we studied the three main types of contracts that are used in currency exchanges: spot, forward, and futures. This chapter discusses the nature and use of currency option contracts.

Options should be viewed as more complex forms of contracts that govern foreign exchange. We will begin with the characteristics of options trades, given their variety and uses. We conclude this chapter with a discussion of the principles underlying option pricing.

After studying the material in this chapter, you will:

Understand what the essence of an option contract is;

You will be able to understand the varieties of option contracts;

Get acquainted with the operations carried out in the currency options markets;

Understand what general economic principles underlie the use of put and call options, respectively, granting the right to sell or buy such contracts for a fixed price;

Understand what costs and risks are associated with the use of currency options;

Understand what economic factors determine option premiums.

CURRENCY OPTIONS

Forward and futures contracts impose on the investor an obligation to exchange a certain amount of one currency for another at a specified time in the future. The investor must make such an exchange, even if the transaction has become unprofitable for him. But many investors prefer a situation where making a currency exchange is not an obligation for them, but a right: if the planned transaction turns out to be profitable, this exchange should be made; if the transaction is not profitable - refuse to exchange currency.

A contract that provides for such attractive terms is called an option. Under contracts of this type, the investor has the right (but not the obligation) to make a currency exchange. The disadvantage of an option contract is that the investor must pay a high premium to induce the other party to sign such a contract.

Terminology used in options

An option to buy 31,250 British pounds in 3 months at a price of $1.90 per pound gives the option holder the right to buy 31,250 British pounds from the seller of the option. This right is subject to a payment of $1.90 per pound purchased. Therefore, the option holder cannot exercise his right to the pounds without paying them at $1.90 per pound, which is called the strike price of the option. The time when the limiting condition expires (3 months in this case) is called the maturity of the option.

The intrinsic value of an option is the difference between what would be paid for the currency (the market exchange rate) without the option and what would be paid when exercising the option (strike price). For example, suppose 1 English pound is currently selling for $2.00. The intrinsic value of the option is $0.10 per pound (2.00 - 1.90). Because the option does not have to be exercised, its intrinsic value cannot be negative. If the market price of the British pound falls below $1.90, the option's intrinsic value becomes zero.

An option premium is the difference between the market price of an option and its intrinsic value. For example, if an option is sold for $0.15 per pound, the premium is $0.05 per pound (0.15 - 0.10).

TYPES OF CURRENCY OPTIONS

Any two parties may enter into a currency option contract, which will determine, by their agreement, the amount of currency, the maturity and the strike price. Some banks are ready to prepare custom option contracts for their best corporate clients. However, each party is obliged to adhere to the terms of this contract until its expiration date, unless a mutually acceptable replacement for this type of currency exchange is found.

When the number of orders becomes large enough, it becomes possible to organize a secondary market for trading options contracts, similar to the one where transactions with futures contracts take place. In the United States, the Chicago Mercantile Exchange (CME) holds organized sales stock options, and the Philadelphia Securities Exchange - currency.

Closely related options on currency futures contracts are traded on the International foreign exchange market. Although this type of option does not refer to a currency, but to a currency future, it makes no practical difference to option traders.

There is currently an organized market in London for currency options, known as European options, which can only be exercised at a specified time. This distinguishes them from American options, which can be exercised ahead of time. There is little difference in pricing European and US currency options, although European and US stock options value differently.

Options traded on an exchange require a standardized contract form and performance guarantee, just like futures contracts. Currency options expire on the Fridays preceding the third Wednesday of the month. The amount of currency in which each option operates is half that set for futures contracts. The Option Clearing Corporation acts as a guarantor for the exercise of currency options.

Bringing currency futures options in line with the characteristics of futures contracts and guaranteeing their performance is carried out by the International Currency Market.

PUT OR CALL OPTIONS

There are two main types of option contracts. Call options give their holder the right to buy a specified amount of foreign currency at a specified price on a specified date in the future. Puma options give their holders the right to sell, on a specified date in the future, a specified amount of foreign currency at a specified price.

If you exercise your right on a call option, you pay the strike price, and on a put option you get the strike price. The other party to the option who is required to fulfill the conditions at the request of the option holder is called the option writer. She participates in the option for a premium to it, which is paid by its future owner.

Consider the actions of an investor who believes that the value of the British pound will increase from the current 1.95 to 2.10 dollars over the next 6 months. But he also knows that there is a possibility that the value of the pound could drop unexpectedly. Since the investor has limited financial resources, he does not want to risk buying a pound futures contract. He calls his broker and inquires about GBP call options due in June. (If this investor thought the value of the pound would go down, he would be interested in put options.) The broker informs him that a call option with an exercise price of $2.00 is currently selling at a premium of $0.0350. Since both the exercise price and the markup are in dollars, the investor instructs the broker to buy one call option and pays (31250) (0.0350) - $1093.75 (using the numbers from the previous example) plus $25 commission for it.

If, as the option's expiration date approaches, the spot price of the pound rises, then the option increases in value. If the specified price goes up, then the value of the option falls. However, in this case, additional investments will never be required, unlike futures transactions. The investor will not lose more than he originally spent on

this option. The only ones exposed here to the risk of indefinite loss are the option sellers, and they alone must enforce the margin or margin requirement.

While foreign exchange options can be held until maturity and then exercised, holders usually sell them early. Suppose the value of the British pound increased to $2.10 in April. The investor cannot, however, exercise his right before the expiration of this option. The intrinsic value of an option, as defined above, is equal to the difference between market value pound and strike price, i.e. (2.10 ~ 2.00) = $0.10 per pound or (0.10) (31250) = $3125. However, options are usually sold for a price slightly higher than their intrinsic value, and so our investor can simply sell his option before the expiration date.

FACTORS DETERMINING OPTION PRICES

Figure 4-1 shows graphs in which the price and intrinsic value of a foreign exchange call option are plotted as functions of the expected spot exchange rate at the expiration date of the option. Both the intrinsic value of an option and its price are expressed in dollars per unit of foreign currency. The actual value and the price of the option, which must be paid for it, are determined by multiplying the value of a unit of currency by the number of its units provided for in the option contract. The intrinsic value of an option is equal to the difference between the current spot rate and the strike price, but can never be negative, since the investor is not required to execute this type of foreign exchange contract. That is why the continuous line in the figure, showing the change in the intrinsic value of the option, does not depart from the abscissa axis and only fixes the option value on it at zero. This happens until the spot rate exceeds the strike price of the option (X). An increase in the British pound spot rate for every pence increases the option's intrinsic value by 1 pence. Therefore, the line showing the intrinsic value of the option rises from point (X), one to one, corresponding to an increase in the spot rate that exceeds the strike price.

The dotted line represents the market price of the option. At all values of the spot rate, the price of the option exceeds its intrinsic value. The difference between the price investors are willing to pay for an option and its intrinsic value is the option premium.

Investors are willing to pay these premiums because there is the potential for large profits if exchange rates appreciate, and the potential losses are limited even if the exchange rate depreciates. When the exchange rate equals the strike price, the option premium is highest.

When the spot rate is below the strike price of the option and there is little chance that it will exceed it, the markup decreases. When the spot rate is higher than the strike price, the markup still decreases because the price of the option, which is equal to the amount of money the holder has invested in it and can lose, rises.

The option premium is also affected by the term of its exercise and the volatility of the value of the foreign currency in which it operates. Since a longer waiting period increases the likelihood that the exchange rate will exceed the strike price, investors pay more for an option with a longer expiration date. Similarly, a currency that changes its value more dynamically is more likely to have an exchange rate above the strike price.

Figure 4-2 shows the intrinsic value and market price of a put option as a function of the expected future spot price. Put options have value only when

the spot rate falls below the strike price. The intrinsic value is equal to the strike price minus the exchange rate. Since the option owner simply decides not to exercise his right in cases where spot rates exceed the strike price, the intrinsic value of the option is not considered negative, but zero.

As with calls, the market price of a put is usually greater than its intrinsic value. Investors are willing to pay a premium on puts for the same reasons as for calls. Their possible income in case of changes in exchange rates before the expiration of the option expiration of the possible losses, which are limited to the initial costs. The premium is maximum when the exchange rate equals the strike price. It is an increasing function, depending both on the expiration date of the option and on the instability of the currency with which the option operates.

WHO BENEFITS FROM CURRENCY OPTIONS?

Currency speculators like options because they carry unlimited potential gains and at the same time clearly limit losses. However, if option ownership is such a profitable business, why are there those who are willing to sell them? The answer to this question is that the value of the premium that the seller of the option receives is commensurate with the risk of possible unlimited losses.

Why do you still need to deal with option contracts? Investors can profit if they have information about future changes in exchange rates that no one else has. Otherwise, the rest of the participants in foreign exchange transactions would also want to make a profit that significantly exceeds the option premium.

While some companies might benefit from such information, they use options primarily for other purposes. Consider a US company that knows that it will receive 31,250 British pounds in 3 months. It is known that if the value of the pound falls below $1.90, this company has a chance of becoming insolvent. The losses caused by the insolvency far exceed the costs associated with the option of £31,250. That is why the company will pay a substantial premium, but avoid the possibility of becoming insolvent.

Currency futures contracts are standardized forward contracts secured with performance guarantees that are traded on the International currency market. Currency options are similar to futures contracts, with the only difference being that the option holder can choose whether to exercise the contract or not. Currency options may include either the right to sell a currency or the right to buy it. In order to induce someone to issue an option, its future owner must pay a premium for it. It depends on variables such as the difference between the strike price of the option and the value of the currency, the volatility of the value of the option currency, and the expiration time of the option. To use or not to use a currency option? The choice depends on the balance between the premium and the possibly unlimited returns that the option can bring.

A currency option is one of the types of emissive securities. Such a document is especially popular in the foreign exchange market and in banking. It is acquired mainly by traders who earn money by buying and selling foreign currency.

How is a currency option different from a regular option?

An option is a contract, one of the parties of which acquires the right to sell (buy) the underlying asset at a fixed price in a predetermined period of time. Currency refers to a document whose underlying asset is a currency unit. Such securities are very common in interbank relationships and in specialized markets.
Each contract must include the following:
1) Document type. A security can be divided into two types depending on the right that it gives after the acquisition.
2) Underlying asset. The currency pair, which is the main object of the contract, must be precisely specified.
3) Strike price (execution price). The seller of the option is obliged to sell (buy) the asset at this price, regardless of how it has changed over time.
4) Deadline. The buyer can exercise his right only within a certain period, as a rule, from several days to several months.
5) Option premium- the amount of money that the buyer pays the seller at the time of the conclusion of the contract. The fee is a kind of compensation for the risk assigned to the seller, quite often it is called the option price.

Main types of currency options

The contract holder can either sell or buy the underlying asset. Depending on this, the contract can be divided into two types.

call options

A call option (buy option) is a contract in which one of the parties obtains the right to buy the underlying asset. The sale price is agreed in advance and does not change during the entire transaction. The seller is obliged to purchase the asset at the strike price, no matter how much it differs from the market price, in return for which he asks for a small premium.

A currency option is a great way to make money on exchange rate fluctuations. The trader purchases it in the hope that the value of the base currency will increase in the near future. The purchase of a security differs from ordinary investments in a currency with minimal risks, because even if the underlying asset becomes much cheaper, the trader will lose only the money that he gave to the seller as a premium.

An example of using a currency call option

A trader purchases a security to buy euros at the current this moment course (for example, 50 rubles). He does this in the hope that during the validity of the right given to him, the course will begin to rise. The premium is 5% of the amount that can be purchased. If the investor wanted to receive 1000 euros, he must pay 50 to the seller. A currency call is profitable only if the rate increase is more than 5%, otherwise it will give the seller more than it earns on the difference between the strike and the market price.
Let's assume that during the indicated period, the euro has grown by 10%, which means that the investor will receive 5% of the profit from the amount of invested funds, i.e. 10% increase - 5% premium. If you subtract 5% of the amount of 1000 euros, you get a very insignificant profit of 50 euros. Experienced investors work with more impressive amounts, and even such a small increase can give an excellent income.

Put options

A security that gives the holder the right to sell an asset at a specified price is called a put option.
In the foreign exchange market, puts are mostly needed to hedge investments already made in the currency. For example, in the event that a trader keeps his savings in foreign currency, but soon learns about future inflation. Then he acquires a put and can be calm: the funds that he invested will return to him minus the minimum spending on the contract.

An example of using a currency put option

You can earn not only on the growth of the exchange rate, but also on its decline. To do this, you need to sell the currency in the future at a price that is valid at the moment. To do this, many investors use currency puts options.
Suppose that the data of the foreign exchange market indicate an imminent fall in the dollar. Such information is a good reason to earn extra money, but certain difficulties arise here, because in the usual sense, currency inflation is a loss of savings. In fact, with the right approach, even a negative change in the exchange rate can make money.
An investor purchases equity paper for sale a certain amount dollars at the current price and gives 5% of the amount that he wants to realize for such a right. At the time of the contract, the dollar falls by 20%. The trader buys $20,000 at the current price and sells it to the marketer at the strike price. When taking into account the premium, which invariably remains with the seller, the trader earns 15% of the profit from his transaction, i.e. 3 thousand dollars.

"Geographic" types of currency options

For the first time, securities of this kind appeared in Europe, but they found great popularity in America. Gradually, the procedure for exercising the right certified by an option began to change depending on geopolitical attachment: American options operate according to their own principle, European ones - in their own way. In Asia, the American type of security has found another direction of its own.

American option

At the moment, it is the American model that is more popular and widespread. It is used everywhere and, oddly enough, even in Europe.
Its main difference from the European model is that the buyer has access to early expiration - the exercise of data rights in the option.
Early execution of the contract is beneficial for its holder. At the time of its action, the price of an asset can greatly increase or, on the contrary, decrease. The trader has the right to convert the currency at the moment when it will be beneficial for him.

European option

The premiums for such a document are slightly below the average level. The point is that the seller is exposed to minimum risk, since the buyer cannot use early expiration. From the moment the contract is concluded to its execution, a certain period must pass. Only after this time has elapsed can the buyer exercise his right. He will not be able to profit from an intermediate increase (decrease) in the price of an asset.

Asian option

An option is a commodity in some way and must have its own price assigned to it. Since the advent of global options exchanges, many analysts have asked themselves the question: how to calculate the premium correctly.

The most fair calculation model was the one that focuses on the average price of an asset for a certain period. It was first tried by a branch of an American bank in Tokyo. Soon, the contracts, the premiums for which were calculated in this way, were called Asian.

Exotic types of currency options

Gradually, the concept of what a currency option is began to change and take on a completely different form. Types of such documents appeared that are only remotely related to ordinary securities.

Barrier currency options

Options are gambling. Each of the parties to the agreement strives to get the maximum profit, and is ready to lose everything if the outcome is unsuccessful.
Barrier currency options have become the first step towards the transformation of an ordinary security into a global digital market, where the main idea of each participant is to get as much as possible more money.
Barrier contracts differ from the usual ones by the presence of an obstacle to the exercise of the right to acquire or sell an asset: in order for the document to be converted, the price of the underlying asset must reach a certain level.
Since the risk of the buyer increases, the contract indicates a more favorable price for him, which may differ significantly from the market price. For example, the seller undertakes to sell dollars at a price of 35 rubles (at the moment they cost 40) if their price reaches 45 rubles within 1 month.
With the beginning of the popularity of barrier transactions, the underlying asset began to gradually go out of circulation. Instead of buying and selling currency, the seller of the security simply reimbursed the profit that the buyer could receive from his further transactions. This approach is beneficial for both parties: the seller spends less of his time, and the buyer is insured against additional risks, for example, from the fact that in the period from converting a document to reselling an asset, the exchange rate may change to a disadvantage.

Range currency options

In the case of them, the buyer can exercise his right only if the exchange rate at the time of execution of the contract is in a certain range, more (less) than the number n, but not more (less) than the number n + m.
For example, a document for the purchase of a dollar at a price of 35 rubles can be realized only if, at the end of the execution period, the rate will be in the range of 36-40 rubles. The price range is offered by the seller, the buyer has the right to demand its change.
The range can be at the level of the current rate, more than it or even less. In essence, the investor is betting on an increase or decrease in the value of an asset.

Binary options have become the latest step in the transformation of conventional securities. They differ from their ancestors very much and you can trace at least some similarity between them only by learning what barrier and range agreements are.

In binary options, the asset is completely out of circulation. The main object was its price. Traders place bets on its behavior over a certain period of time. If they believe that it will rise, they bet on the “call”, that it will fall - “put”. As you can see. Even the concepts of call and put have lost their former meaning.
The strike price does not depend on the behavior of the asset in the foreign exchange market: it is set by the broker (option seller). The execution price is indicated in percentage to the bet amount. The option premium depends on the buyer: the more he puts, the more he gets and the more he can lose. The premium remains with the broker only if the investor's bet has not played. It turns out that in any case, with money on hand, only one side of the agreement remains, which is why such transactions are often called “all or nothing”.

Currency options in banking legal relations

At the moment, second-tier banks are the most accessible options seller. They distribute securities, both among individuals and among legal entities.
Ordinary citizens can purchase this security as a guarantor of the reimbursement of a deposit in foreign currency. Options for individuals is a new direction in banking investment, so it is worth talking about it in more detail.
Currency option with deposit coverage- this is an opportunity to receive a more favorable interest on the deposit and at the same time quite a serious financial risk. In fact, this is a put option: the client opens a deposit in the base currency and acquires the right to sell this currency to the bank. The document specifies the rate that the client himself chooses, as well as the amount of the bank's premium. The range of the possible exchange rate is chosen by the bank. The contract has a period of one week to a month. If, after this period, the exchange rate chosen by the client is more profitable than the current one, he can use his issuing document and convert savings into foreign currency at a more favorable exchange rate. In addition, the bank returns the amount of the premium.
If the selected rate is lower than the current one, the client leaves his right unclaimed, and the premium remains with the bank.
That is, for example, a client opens a deposit in the amount of 100 thousand rubles and acquires an option from the bank to convert this amount into dollars at the rate of 38 rubles. At the moment, the exchange rate is 40 rubles. The deadline is one week. For the contract, the client must pay 10% of the deposit, but only if he does not use it.
If at the end of the contract the dollar exchange rate remains unchanged or even increases, the client remains in the black. He uses his right and converts the deposit into dollars at a rate below the market. The bank reimburses the value of the security as a bonus. If the dollar exchange rate fell below 38 rubles, it would be unprofitable for the client to use the option. He simply lets it burn out and in doing so loses 10,000 rubles (option premium).
No matter how welcoming it may sound, such a banking offer is not very profitable. The bank puts forward clear conditions that do not allow the client to make a big profit. The interest on the deposit is usually lower than the market average and the favorable change in the exchange rate only covers this difference.

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A currency option is a contract between a buyer and a seller that gives the buyer the right, but not the obligation, to purchase a certain amount of currency at a predetermined price and within a predetermined period, regardless of the market price of the currency, and imposes on the seller (writer) an obligation to transfer to the buyer currency within a specified period, if and when the buyer wishes to carry out an option transaction.

A currency option is a unique trading instrument, equally suitable for trading (speculation) and for risk insurance (hedging). Options allow you to adapt the individual strategy of each participant to market conditions, which is vital for a serious investor.

The prices of options, compared to the prices of other currency trading instruments, are influenced by a larger number of factors. Unlike spots or forwards, both high and low volatility can create profitability in the options market. For some, options are a cheaper currency trading tool. For others, options mean greater security and accurate execution of orders to close a losing position (stop-loss orders).

Currency options occupy a rapidly growing sector of the foreign exchange market. Since April 1998, options occupy 5% of the total volume on it (see Fig. 3.1.). The largest option trading center is the US, followed by the UK and Japan.

Option prices are based on and are secondary to RNV prices. Therefore, an option is a secondary instrument. Options are commonly referred to in connection with risk insurance strategies. Traders, however, are often confused about both the complexity and ease of use of options. There is also a misunderstanding of the possibilities of options.

In the foreign exchange market, options are available for cash or in the form of futures. From this it follows that they are traded either “over the counter” (over-the-counter, OTC), or on a centralized futures market. The majority of foreign exchange options, approximately 81%, are traded OTC (see Figure 3.3.). This market is similar to the spot and swap markets. Corporations can contact banks by phone, and banks trade with each other either directly or through brokers. With this type of dealing, maximum flexibility is possible: any volume, any currency, any term of the contract, any time of the day. Number of currency units

can be integer or fractional, and the value of each can be estimated both in US dollars and in another currency.

Rice. 3.3. Distribution of option trading volumes between the OTC market and the organized foreign exchange market: 1 - OTC sector; 2 - sector of organized trade.

Any currency, not just those available in futures contracts, can be traded as an option. Therefore, traders can operate with the prices of any, the most exotic currency that they need, including cross-prices. Any validity period can be set - from several hours to several years, although basically the terms are set, focusing on integers - one week, one month, two months, etc. RNV works continuously, so options can be traded literally around the clock.

Trading options on currency futures gives the buyer the right, but does not impose the obligation, to physically own the currency futures. Unlike futures foreign exchange contracts, the purchase of foreign exchange options does not require an initial cash reserve (margin "a). The cost of the option (premium), or the price at which the buyer pays the seller (writer ^), reflects the overall risk of the buyer.

The following seven main factors affect option prices:

1 . Currency price.

2. Selling price (strike (exercise) price).

3. Currency volatility.

4. Validity.

5. The difference in discount rates.

6. Type of contract (call or put).

7. Option model - American or European.

The currency price is the main pricing component and all other factors are compared and analyzed taking into account this

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prices. It is the changes in the price of the currency that determine the need to use the option and affect its profitability. The impact of a currency's price on an option premium is measured by the "Delta" index, the first Greek letter used to describe aspects of pricing when discussing factors that affect the value of an option.

Delta, or simply A, is the first derivative of the option pricing model (PPM).

This index can be viewed in three aspects:

1 . As a change in the price of a currency option (CVO) relative to a change in the price of a currency. For example, a change in the price of an option from A=0.5 is expected to be half the change in the price of the currency. Therefore, if the price of a currency rises by 10%, the price of an option on that currency will rise by an estimated 5%.

2. As the degree of risk insurance (hedge ratio) of an option relative to a currency futures, necessary to establish a balanced risk (neutral hedge). For example, if A=0.5, you would need two option contracts for each of the futures contracts.

3. As a theoretical or equivalent equity position. With this approach, "Delta" is a part of the currency futures, in which the buyer of call^ is in the "buy" position (long) or the buyer of pU/a is in the "sell" position (short). If we use the same indicator A=0.5, this would mean that the buyer of the put option sells 1/2 of the currency futures contract.

Traders may not be able to guarantee prices in the spot, non-reversible forward or futures markets, leaving the Delta position temporarily unhedged. To avoid the high cost of insurance and the risk of unusually high volatility, a trader can hedge positions in the original option with other options. Such methods of risk neutralization are called "Gamma" or "Vega" insurances.

Gamma (G) is also known as the curvature of the option. This is the second derivative of the option pricing model (OPM) and represents the degree of change in the option's Delta, or the sensitivity of the Delta. For example, an option with A=0.5 and Y=0.05 is supposed to have A=0.55 if the price of the currency rises by 1 point, or A=0.45 if the price falls by 1 point. "Gamma" varies from 0 to 100%. The higher the Gamma, the higher the Delta sensitivity. Therefore, it may be appropriate to interpret "Gamma" as an indicator of the acceleration of the option in relation to the movement of the currency.

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"Vega" characterizes the effect of volatility on the premium value for an option. "Vega" (=) characterizes the sensitivity of the theoretical option price to changes in volatility. For example, z=0.2 creates a 2% increase in premium for each percentage increase in estimated volatility and a decrease in premium by 2% for each percentage decrease in estimated volatility.

An option is sold for a specified period of time, after which there is a date known as the expiration date. The buyer wishing to exercise the option must notify the writers on or before the expiration date. Otherwise, it releases the writer^ from any legal obligations. The option cannot be exercised upon expiration.

Theta (T), an index also known as fading over time, is used when the theoretical value of an option is lost due to very slow or no currency movement at all.

For example, T=0.2 means a loss of 0.02 premium^ for each day the currency price does not change. The internal price does not depend on time, but the external one does. The fading in time increases as the expiration approaches, as the number of possible exits continually decreases over time. The influence of the time factor is maximum for the at-the-money option and minimum for the in-the-money option. The degree of influence of this factor on the out-of-the-money option is somewhere within this interval.

Bid-offer spreads in the foreign exchange market can make selling options and trading irreversible forwards too costly. If the option is deep into the money, the difference in discount rates achieved by the quick exercise may exceed the value of the option. If the option is small or close to expiration and the value of the option consists only of its intrinsic value, early exercise may be preferable.

Option(in English option, from Latin optio - choice, desire, discretion) or option contract- this is a contract under which a potential seller or potential buyer acquires the right, but not the obligation, to sell or purchase an asset (goods) at a predetermined price at a certain point in the future or during a certain period of time. An option is one of the . There are options to sell (put option), to buy (call option) and bilateral (double option).

Options types

An option can be a buy or a sell.

call option- option to buy. Gives the option buyer the right to buy the underlying asset at a fixed price.

Put option- put option. Gives the option buyer the right to sell the underlying asset at a fixed price.

Accordingly, four types of transactions with options are possible:

buy call option
write (sell) call option
buy put option
write (sell) put option

Options types

Depending on the underlying asset, there are four main types of options:

Interest

Options on Interest Futures
Options on future interest rate agreements – interest rate guarantees
Options on interest rates –

Currency

Cash Options
Options on currency futures

Stock

Options on (issuer options)
Options on index futures

Commodity

Options on physical goods
Options on commodity futures

Options Styles

The most common options are of two styles - American and European.

American option can be redeemed on any day of the term before the expiration of the option. That is, for such an option, the period during which the buyer can exercise this option is set.

European option can only be redeemed on one specified date (expiry date, exercise date, redemption date).

Option premium

Option premium is the amount of money paid by the buyer of an option to the seller when concluding an option contract. In economic essence, the premium is a payment for the right to make a deal in the future.

Often when people say "option price" they mean the option premium. The premium of an exchange option is the quote for it. The premium value is usually set as a result of the equalization of supply and demand in the market between buyers and sellers of options. In addition, there are mathematical models that allow you to calculate the premium based on the current value of the underlying asset and its stochastic properties (volatility, profitability, etc.).

Option pricing models

At the heart of all mathematical models for calculating the price of an option, lies the idea of an efficient market. It is assumed that the "fair" premium of an option corresponds to its value, at which neither the buyer of the option nor its seller, on average, make a profit.

To calculate the premium, the properties of a stochastic process are postulated that simulate the behavior of the price of the underlying asset underlying the option contract. The parameters of such a model are estimated based on historical data. One of the most important statistical parameters affecting the value of the premium is the price volatility of the underlying asset. The larger it is, the greater the uncertainty in predicting the future price, and, therefore, the greater the premium (for risk) that the seller of the option must receive. The second important parameter, also directly related to uncertainty, is the time until the option expires. The further to this date, the higher the premium (for the same delivery price of the underlying asset, specified in the option contract).

Most popular optional models:

(Black-Scholes)
Binomial Model
Heston model
Monte Carlo Model
Bjerksund-Stensland model
Cox-Rubinstein model
Yates model

exotic options

An option contract, at the conclusion of which the type of underlying asset, the volume of the contract, the purchase or sale price, the type and style are specified is called a standard or plain vanilla option. With the development of the market, additional variables began to be included in the terms of option contracts in response to requests from buyers caused by the characteristics of the risk that they would like to hedge options. Since the over-the-counter options market is flexible, the additional clauses simply reflected on the premium, lowering or increasing it.

Particularly successful inventions began to be offered on the market in droves. So there were non-standard (non-standard) or exotic options (exotic options or simply exotics). The end of the 80s is considered to be the time of the emergence of the exotic options market.

TO exotic options include Asian, barrier, compound options, and swaptions.

Options Markets

The entire history of option markets can be divided into two periods - exchange and non-exchange.

The first mention of options dates back to the second millennium BC. The first reliably known hedging-type investment was a call option trade and appears to have taken place about 2,500 years ago. Aristotle relayed the story of the poor philosopher Thales, who demonstrated to skeptics that he had invented a "universal financial mechanism" and profited by contracting with the owners of olive presses for the exclusive use of their equipment to process the forthcoming harvest. The press owners were happy to pass on the risk of future olive prices and receive payment up front as a hedge against a bad harvest. It turned out that Thales correctly predicted a rich harvest, and the demand for the services of olive presses increased. He sold his winepress rights and made a profit. In the call option, Thales only risked his down payment. Although he did not invest in fields, workers, or olive presses, he actively participated in the production of olives, taking on risks that the olive farmers and press owners could not or did not want to take - and allowed them to focus on the production and processing of olives. They got income from their work, and he from his.

Another fairly well-known mention of options is the tulip boom in Holland. Tulip traders, wanting to hedge their ability to build up inventories when prices rose, bought call options that gave them the right, but not the obligation, to buy the commodity within a specified time period at a specified price. Florists, seeking protection from falling prices, bought put options, giving them the right to deliver or sell tulips to another party at a predetermined price. The other side in these options, the sellers, assumed the risks in exchange for the premiums paid by the option buyers. Sellers of call options were compensated for the risk of rising prices, and sellers of put options were compensated for the risk of falling prices. After this incident, and also after a series of collapses of financial pyramids in Britain that occurred at the beginning of the 18th century, in 1720, the “Bubble Act” was adopted - the law on “Soap Bubbles”, according to which the status of “ limited liability» (limited liability) could be obtained only on the basis of a special act of Parliament. Around the same time, a recognized futures market existed in Japan, where landowners who received a rent in kind (a share of the rice harvest) insured themselves against crop failures with options.

In the US, options have been used for a long time. Put and call options have been traded on the stock exchange since the 1790s, shortly after the famous Plane Tree Agreement (1792) that launched the New York Stock Exchange. stock Exchange. During the American Civil War, the Confederate government used a financial product made up of a bond and a cotton option for the bondholder to finance foreign arms purchases. At the same time, this ensured the formation of a foreign clientele interested in the survival of the Confederation. The risk of depreciation of the Confederate dollar was covered by the right to receive British or French currency for bonds. The possibility of getting cotton in debt protected against inflation and was enticing because cotton was offered at 6d at European prices of about 24d. In addition, the bonds were convertible into cotton "at any time". This opportunity protected from the vicissitudes of war those creditors who, having shown promptness, managed to acquire their cotton before the final defeat of the Confederates.

In 1848, the world's largest stock exchange, the CBOT (Chicago Board of Trade), was founded in Chicago. At that time, this exchange traded mainly in grain, then forward contracts for grain and options appeared in circulation. Options appeared there by the 60s of the XIX century, and at the beginning of the XX century, the Association of Brokers and Dealers for Options (Put and Call Brokers and Dealers Association) appeared.

However, the real beginning of the history of modern derivatives is considered to be the 1970s, when futures contracts for foreign currency began to be traded on SWOT. After the prohibition in 1972 of trading in futures and stock options on the SWOT, in 1973 the CBOE (Chicago Board Options Exchange) was created, which became a real revolution in the world of options. The fact is that the appearance of CBOE actually meant the release of futures contracts to a new level - the level of a standardized exchange financial product.

Prior to the introduction of exchange trading, call and put options were traded "over the counter" in the over-the-counter market. In this form of the market, there were several option dealers. They found the buyer and seller of the contract, helped them come to an agreement on the terms of the contract, and carried out the transaction. Dealers usually took a commission from the transaction price. Options of this type typically had an exercise price equal to the current share price; thus, if the stock was selling at 46 3/8 at the time the contract was entered into, then that price was the strike price of the option. This led to inconvenient calculations. In addition, these OTC options had fixed expiration dates linked to the time the contract was entered into: one could choose from 6 months plus 10 days, 95 days, 65 or 35 days.

Another unusual condition is that the call holder receives the dividend before exercise, meaning that the strike must actually be adjusted by the amount of the dividend paid over the life of the option. In addition to the rather difficult task of finding complete absence secondary market.

And so, on April 26, 1973, the Chicago Board Options Exchange opened its doors. The trading volume on the first day was 911 option contracts for 16 shares. In addition to standardizing the terms of option contracts, the exchange introduced a system of market makers for the markets for listed shares and was also responsible for the Option Clearing Corporation (OCC) - the guarantor of all option transactions. Both the first and second are very important to ensure the viability of the new exchange in terms of market breadth, liquidity and the reliability of the execution process.

Thereafter, the stock options market grew at a rate beyond description: the American Stock Exchange (AMEX) listed options in January 1975, and the Philadelphia Exchange in June. Moreover, the success of the exchange-traded options market eventually accelerated the development of options as we see them today. The continued introduction of new products - such as index options - and the resulting growth and revival of the related exchanges are directly related to the success of the Chicago Board Options Exchange. The old OTC market has shrunk significantly, with the exception of non-listed stock options.

The next important innovation is the emergence of index trading. The Chicago Board Options Exchange introduced the first options on the OEX index on March 11, 1983. Today, the OEX is better known as the S&P 100 Index, but still bears the ticker OEX. He is by far the most successful product among stock and index options throughout the history of stock options.

In the meantime, the Chicago Mercantile Exchange (CME) began trading index futures, whose success and influence extended far beyond the futures and options trading arena, and which eventually became the "king of index trading" and subsequently the instrument that was accused in the stock market crash of 1987 and many other stock market turbulences (referring to Macmillan).

The reason for the popularity of index contracts is that, firstly, the investor could follow the market as a whole and act directly from this vision. Before the advent of index products, an investor had to realize his vision of the market by buying a fairly large number of individual shares. As you know, you can be right about the market as a whole and be wrong about a specific paper. The ability to trade indices and options on indices solves this problem.

The first futures options began to be traded in 1972 - these were options on currency futures and they were traded on the CME. The first stock options on interest rate futures appeared in 1975. This was followed by Treasury bond futures in 1976. However, the most popular contracts - 30-year US government bonds and eurodollar futures - were only listed in 1977 and 1981, respectively. Options for these products appeared only a few years later (in 1982 - on, in 1986 - on Eurodollars). The first agricultural options - on soybeans - appeared on the listing in 1984.

Today, there is also a huge amount of trading in options contracts, unaccounted for in the statistics of the exchanges, since today there is again a powerful OTC market for derivatives. financial instruments. And although the modern OTC market is much more experienced than its predecessor, both of these markets have certain similarities. The main similarity is that the contracts traded in these markets are not standardized. Today's large financial institutions that use options tend to tailor them to their portfolios and positions that need to be hedged. Moreover, they may need expiration dates other than the standard ones. A very big difference between the modern over-the-counter market and the over-the-counter market of past years is that today contracts are issued mainly by large investment companies. These companies hire option strategists to hedge their portfolio as a whole, which bears little resemblance to the trading of yesteryear when brokerage firm she simply found a seller and a buyer, and then brought them together to close the deal. However, exchanges are making attempts to shift over-the-counter trading to the exchange market space. CBOE has already introduced so-called FLEX options, which have variable expiration dates and strike prices, as an initial step in introducing new products to the market.

Main dates of the exchange period:

before 1973 - non-exchange stock options
since 1973 - stock options
since 1981 - interest rate options (on bonds, mortgages, treasuries)
since 1982 - currency options, options on bond futures contracts
since 1983 - options on stock indices, options on futures contracts on stock indices

The ancestor of stock options trading is the Chicago Chamber of Commerce(exchange) - CBOT, which created by the beginning of 1973 a specialized branch - the Chicago Board Options Exchange (CBOE). Stocks were the original asset of stock options. American companies most in demand on the stock market.

Option exercising

Who has an option, call or put, has the right to exercise this option before the expiration date, thereby turning it into the underlying asset in the first case or in the second.

A trader who executes an October 21 crude oil call is long a single October futures contract at $21 per barrel.

A trader exercising a March 80 put on CE stock takes a short position in 100 CE shares at $80 per share. If the option is exercised, its effect is terminated, as in the case of the expiration of the option without exercise.

To exercise an option, a trader must send a notice to either the seller if the option is purchased from a dealer, or to the guarantor (clearing organization) if the option is purchased on an exchange. Upon receipt of a properly drafted notice, the seller of the option is appointed. Depending on the option type, the seller is required to take either a long or short position in the underlying contract (buy or sell the underlying contract) at a set strike price.

Options are characterized not only by the underlying asset, strike price, expiration date and type, but also by the conditions of execution. They are American, that is, allowing execution at any time before the expiration date, or European, that is, allowing execution only on the expiration date2. The vast majority of stock options in the world are American, that is, allowing for early exercise. This style includes all U.S.-listed stock options and futures.

As in any competitive market, the price of an option, or premium, is determined by supply and demand. Buyers and sellers make competitive offers to buy and sell in the market. When the bid price matches the bid price, a trade is made. The premium paid for an option has two components: intrinsic value and time value.

Option intrinsic value is the amount that will be credited to the account of the option holder if he exercises the option and closes the position in the underlying contract at the current market price.

For example, if gold is trading at $435 per ounce, then the intrinsic value of the 400 call is 35. By exercising the option, the holder of the 400 call can buy gold at $400 per ounce.

If he sells an ounce of gold at the market price of $435, then $35 will be credited to his account. If shares are sold at $62, then the intrinsic value of 70 puts is 8.

By exercising the option, the put holder will be able to sell the shares for $70 each. If he then buys them again at the market price of $62, he will earn $8.

A call option has intrinsic value only if its strike price is below the current market price of the underlying contract. A put option has intrinsic value only if its strike price exceeds the current market price of the underlying contract. The intrinsic value of an option depends on how much lower the strike price of the call or the strike price of the put is above the current market price of the underlying contract.

The intrinsic value of an option cannot be less than zero.

Typically, the price of an option in the market is greater than its intrinsic value. The additional amount that traders are willing to pay on top of the option's intrinsic value is time value.

It is sometimes referred to as the time premium or the option's extrinsic value. As will be shown below, market participants pay more for an option because it is less risky than a long or short position in the underlying contract.

An option's premium is always the sum of its intrinsic value and time value. If a 400 gold call is trading at $50 and gold is $435 an ounce, then the time value of the call is $15 because its intrinsic value is $35.

The sum of both components should add up to an option premium of $50. If 70 puts on the stock sell for $9 and the shares sell for $62, then the time value of the option is $1 because its intrinsic value is $8.

The sum of intrinsic value and time value should give the option premium, i.e. $9.

An option premium is always the sum of intrinsic value and time value, but it is possible for one or both of these components to be zero.

If an option has no intrinsic value, then its price in the market is equal to its time value.

If an option has no time value, then its price is equal to its intrinsic value. In the latter case, the option is said to be trading at parity. While the intrinsic value of an option cannot be less than zero, the time value of European options can be negative (see the part on option early exercise).

In such cases, the option trades below parity. However, as a rule, the premium components of an option are not negative. An option with positive intrinsic value is said to be in the money by the amount of intrinsic value. If the stock is worth $44, then 40 calls are in the money at $4. If the Deutsche Mark is 57.75, then 59 puts are in the money at 1.25. An option that has no intrinsic value is said to be out of the money.

The price of such an option is equal to the time value. For a call (put) to be in-the-money, its strike price must be lower (higher) than the current price of the underlying contract.

Note that if the call is in the money, then a put with the same exercise price and the same underlying contract must be out of the money. Conversely, if the put is in the money, then the call with the same exercise price must be out of the money. Finally, an option whose strike price matches the current price of the underlying contract is said to be in the money. Technically, such an option is out of the money, as it has no intrinsic value.

However, we draw a distinction between in-the-money and out-of-the-money options because the time premium for in-the-money options is larger and they are heavily traded.

Strictly speaking, the strike price of an in-the-money option is equal to the current price of the underlying contract. However, in exchange practice, calls and puts with the strike price closest to the current price of the underlying contract are classified as "at the money". If the stock is worth $74 and the strike prices change in increments of $5 (65.70.75.80), then 75 calls and 75 puts would be considered money options, i.e. call and put options, the strike prices of which are the most close to the current price of the underlying contract.

Currency options occupy a rapidly growing sector of the foreign exchange market. Since April 1998, options occupy 5% of the total volume on it. The largest option trading center is the US, followed by the UK and Japan.

The following seven main factors affect option prices:

1. Currency price.

2. Selling price (strike (exercise) price).

3. Currency volatility.

4. Validity.

5. The difference in discount rates.

6. Type of contract (call or put).

7. Option model - American or European.

Foreign exchange premium - a positive difference between the formal and the current exchange rate.

Types of currency options: call option, put option

An option can be to buy or sell the underlying asset.

A call option is an option to buy. Gives the option buyer the right to buy the underlying asset at a fixed price.

A put option is an option to sell. Gives the option buyer the right to sell the underlying asset at a fixed price.

Accordingly, four types of transactions with options are possible:

§ buy call option

§ write (sell) call option

§ buy Put option

§ write (sell) Put option

Buying a call option

This strategy is most often used when the price of a certain commodity is expected to rise.

In this case, the investor's risk is limited only by his premium - part of the price of the goods. In a situation where he buys 80 calls, the premium is 5. This means that he only risks those five. This means that buying an option involves less risk than buying a specific commodity. However, even in this case, the premium is at risk, so there is a possibility of losing the entire investment, even if the investment amount was small.

Less risk means less income. The profit from buying options is quite small. This is due to the fact that, according to the contract, transactions can only be performed at a fixed price.

Selling a call option

When selling a call option, the seller takes quite a risk because he must provide the goods at a predetermined price, the so-called naked strategy.

With this risk, the maximum profit the seller can make is the premium. So, when he buys 80 calls, the premium is 5. Selling a call to open a position is what is called a short call.

Buying a put option

In this case, as with the sale of a call option, the risk is limited only by the size of the premium. The purchase of an option is made in order to receive income from a fall in the price of a certain asset. The shareholder acquires the right to sell the asset at a fixed price, while he will receive a profit only if the price of the asset falls.

The holder can receive the maximum income from this transaction only if the prices of the goods fall to zero. Buying a put option to open a position is a long put option.

Selling a put option

When selling a put option, the holder takes quite a lot of risk, as he is obliged to deliver a certain commodity at a fixed price. At the same time, if the market price of an asset falls, the seller is forced to pay a large amount of money for the depreciated goods. If the asset price drops to zero, the investor will lose the strike price and premium.

As for the income from the sale of the option, it is made with the expectation that there will be no request for its implementation. Selling a put option to open a position is a short put option.

Option style.

Options differ in style: European option, or European style option (European option, European style) and American option, or American style option (American option, American style).

The main difference between them is that they have different execution conditions in terms of time. Further, it will be possible to see that, due to the influence of such a factor as the life of an option contract, the values (premiums) of European and American options are different.

The European option can only be exercised for a very limited period of time around the option's expiration date. Formally, it is considered that this is the day that is defined as the date of execution of option contracts. However, the practice of placing orders and the reconciliation procedure predetermine somewhat more wide borders, which nevertheless still fit into a certain number of hours that do not expand horizons too much.

The American option can be exercised at any time before the expiration of the option. For such an option, the execution is determined solely by the rules that are in force at the current time in relation to the timing of delivery of the asset underlying it, as well as the capabilities of the broker through which one is carried out. radios on the market. There may also be restrictions on the number of option contracts executed during one trading day. Usually this is 2000 option contracts.

The scenario of the execution of a currency option with a deposit coverage. Currency option with deposit coverage: features, conditions

How is a currency option different from a regular option?

Main types of currency options

call options

An example of using a currency call option

Put options

An example of using a currency put option

"Geographic" types of currency options

American option

European option

Asian option

Exotic types of currency options

Barrier currency options

Range currency options

Currency options in banking legal relations

Options types

Options types

Interest

Currency

Stock

Commodity

Options Styles

Option premium

Option pricing models

exotic options

Options Markets

Option exercising

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