FINS3616 · International Business Finance
Currency Futures and Options
Week 4 of UNSW FINS3616 contrasts currency forwards and futures — standardisation, margining and daily marking-to-market — and introduces currency options (Shapiro Ch 7). You draw and compute call and put payoff and profit profiles and see how options hedge asymmetric FX exposure: an importer buys a call to cap a payable, an exporter buys a put to floor a receivable. The terminology and payoff arithmetic are examined in both the 35% mid-term and the 40% final.
What this chapter covers
- 01Currency futures: exchange-traded, standardised size and maturity, marked-to-market daily with initial and maintenance margin via a clearinghouse
- 02Forwards vs futures: OTC/custom and no interim cash flow vs standardised/marked-to-market; counterparty risk; futures price converges to spot at expiry
- 03Currency options: the right (not obligation) to buy (call) or sell (put) at a strike; the buyer pays a premium and maximum loss = premium
- 04Moneyness: a call is in-the-money when spot > strike, a put when spot < strike; option value = intrinsic value + time value
- 05Payoff versus profit at expiry per unit: long-call payoff = max(S_T − X, 0) and profit = payoff − premium; long-put payoff = max(X − S_T, 0) and profit = payoff − premium
- 06Determinants of a currency option value (Garman–Kohlhagen): spot, strike, domestic and foreign interest rates, volatility, time; higher volatility raises both calls and puts
- 07Currency put–call parity: C − P = S·e^(−r_f·T) − X·e^(−r_h·T)
- 08Hedging use: importer buys a call to cap purchase cost; exporter buys a put to floor proceeds; options fit contingent/uncertain exposures
Hedging a foreign payable with a currency call
- +1State the per-unit long-call payoff, max(S_T − X, 0), and the profit, payoff − premium, with maximum loss equal to the premium of 0.03 USD/EUR. The importer exercises only when S_T > X = 1.10.
- +1(a) S_T = 1.16: payoff = max(1.16 − 1.10, 0) = 0.06; net option profit = 0.06 − 0.03 = 0.03 USD/EUR gain, i.e. €500,000 × 0.03 = $15,000. The importer exercises and buys euros at 1.10; effective all-in cost = strike + premium = 1.13 USD/EUR (below the 1.16 market).
- +1(b) S_T = 1.05: the call is out-of-the-money and lapses; loss = the 0.03 premium = €500,000 × 0.03 = $15,000. The importer buys euros in the market at 1.05; effective all-in cost = 1.05 + 0.03 = 1.08 USD/EUR.
- +1Interpret: the call caps the euro purchase cost at 1.13 (strike + premium) if the euro rises, while leaving the importer free to buy cheaply if the euro falls (all-in 1.08 at S_T = 1.05). That one-sided protection — cap the downside, keep the upside — is exactly what a forward cannot provide.
Key terms
- Currency futures
- Exchange-traded, standardised contracts to buy or sell a fixed amount of currency on a fixed date at a rate set today. They are marked-to-market daily against initial and maintenance margin through a clearinghouse, so counterparty risk is low and positions are usually closed out before delivery.
- Forward vs futures
- Forwards are OTC, custom-sized and have no interim cash flows but higher counterparty risk; futures are standardised, exchange-traded and marked-to-market daily. The futures price converges to the spot price at expiration.
- Currency call / put
- A call is the right (not obligation) to buy a currency at the strike; a put is the right to sell at the strike. The buyer pays a premium and can lose at most that premium. A call is in-the-money when spot > strike; a put when spot < strike.
- Option payoff versus profit at expiry
- Per unit, a long call's payoff is max(S_T − X, 0) and a long put's is max(X − S_T, 0) — never negative. Profit is that payoff minus the premium, so a buyer's maximum loss is the premium and the break-even is X + premium for a call, X − premium for a put. Option value = intrinsic value + time value; higher volatility raises the value of both calls and puts.
- Currency put–call parity
- For European currency options, C − P = S·e^(−r_f·T) − X·e^(−r_h·T), linking a call, a put, the spot and the strike through the two countries' interest rates.
- Marking-to-market
- The daily crediting/debiting of futures gains and losses to the margin account; if the balance falls below the maintenance level a margin call restores it to the initial margin. This is the key cash-flow difference from a forward.
Currency Futures and Options FAQ
When should a firm hedge with an option rather than a forward?
Use an option when the exposure is contingent or uncertain, or when you want to keep the upside. A forward locks a single rate and removes both the downside and the upside; an option pays a premium to cap the bad outcome while leaving the good outcome open. An importer with a payable buys a call to cap the purchase cost; an exporter with a receivable buys a put to floor the proceeds. If the exposure is certain and you just want it gone at the lowest cost, a forward is usually cheaper because there is no premium.
What is the effective cost of a payable hedged with a call?
If the call is exercised, the effective all-in cost per unit is the strike plus the premium; if it lapses (the currency fell below the strike), the effective cost is the market spot plus the premium. The premium is paid either way, so it always enters the cost. The call therefore caps your maximum cost at strike + premium while letting you benefit if the currency falls — that is the whole point of the asymmetric payoff.
How do currency futures differ from forwards in the cash flows?
A forward has no cash flow until delivery, so all the gain or loss lands at maturity, and it carries counterparty risk. A futures contract is marked-to-market every day: gains are credited and losses debited to a margin account, and a margin call tops the account back up if it falls below the maintenance level. That daily settlement and the clearinghouse make futures much lower in counterparty risk, at the cost of interim cash flows and standardised sizes/maturities.
Can AI help me with currency options in FINS3616?
Yes. Sia is an AI tutor built to mirror how FINS3616 is taught and assessed at UNSW Sydney: it can walk you through a call or put payoff and profit calculation, the effective all-in cost of a hedged payable or receivable, and the six determinants of a currency option value, one step at a time. It checks your reasoning but does not do graded assessment, and UNSW academic-integrity rules apply — use it to be ready for the payoff questions on the mid-term and final.
Exam move
Get the payoff formulas exact and always remember the premium enters the cost or profit in every state, exercised or not. Rehearse both hedging directions until they are automatic: an importer/payable buys a call and caps the all-in cost at strike + premium; an exporter/receivable buys a put and floors the all-in proceeds at strike − premium. Draw the profit profile each time (flat at −premium, then a 45° line past the strike) so you can read off break-even and the capped/floored outcome without re-deriving. Keep the forwards-versus-futures contrast (standardisation, margining, daily marking-to-market, counterparty risk, convergence at expiry) ready as a short-answer, and know the six determinants of a currency option value and that higher volatility raises both calls and puts. This is Week 4 material, so it is examined in the 35% mid-term and again in the cumulative 40% final; rehearse the recorded tutorial questions under time. When the sign or break-even won't click, ask Sia to re-run the payoff at a fresh strike, premium and spot.
Working through Currency Futures and Options in FINS3616? Sia is AskSia’s AI Business and Economics tutor — ask any FINS3616 Currency Futures and Options question and get a clear, step-by-step explanation grounded in how FINS3616 is taught and assessed. Read this chapter free, then take your hardest questions to Sia.
