Point Counter Point

Point Counter-Point

Name: Ouma

Point Counter-Point

Should Speculators Use Currency Futures or Options? Who is correct?

The term ‘Speculators’ points towards a diverse group of people. Mostly they are individuals, representing banks, other financial bodies, or multinational corporations, and their purpose of playing in the market is to make profits by buying and selling foreign currency using FX derivative.

There are various advantages and disadvantages of using futures or options. A speculator would certainly go for a currency future when he is confident of his expectations of minimum risk, and absolutely he would be able to avoid the payments in respect of premiums. While conversely if the movement of the currency goes in the opposite direction from that expected and planned for, then the speculators would have to bear huge losses (those losses may be unlimited).

In case the speculators foresee risk in the market they will always go for purchasing currency options to minimize the risks by paying substantial premiums. If in case the movements of the prices of the underlying assets and forex market are according to the expectations of the speculators then they earn limitlessly on their capital invested. Though, if the prospects of the investments go in the opposite direction, then the loss the speculators have to bear is limited the amount of premium only. Using currency options the speculators are able to keep themselves safe from the adverse movements of the FX market and limit the potential losses which otherwise may have incurred in case of currency futures.

From the above paragraphs, it can be inferred that both currency futures and options have their own advantages and disadvantages. It is up to the speculator’s mind that how he wants to play in the market, and which option he chooses to stay within the limits of his risk-bearing capacity.

I would support the Counter-Point argument. If the speculator goes for speculation, he must keep his side safe by limiting his downside risk on the cost of the option premium. There would be unmeasurable and unexpected earnings if the movements of the price are according to the expectations of the speculators. They must at least have secured themselves from potential losses by hedging their risk by choosing the currency options.

Self-Test

Net profit per unit of the dollar and for one contract

Net Profit/unit = Spot Rate - Strike Price - Premium per unit

= $0.65 - $0.60 - $0.06

= -$0.01

Net Profit for one Contract = Profit per unit x Total number of units

= -$0.01 x 50,000 Units

= -$500

Price per unit to break even = $0.66

Seller’s profit per unit = Loss to the speculator i.e., $0.01/unit and $500/contract

Put options become valuable for the buyers the put option if the spot rate at the time of expiry is lower than the strike price. In the given case the speculator should exercise the options. The net profit per unit to the speculator in this case is:

Net profit/unit = Strike price – spot price at expiry – premium paid

= $0.80 - $0.74 - $0.02

= $0.04/unit

And, the seller would bear a loss because the profit has been earned by the buyer.

Net loss/unit to the seller = Net profit/unit to the buyer

Net loss / unit to the seller = $0.04 or otherwise ($0.02 + 0.74 - $0.80 = $-0.04)

Buying long-term currency options technique is not so popular for some industries, and is not used by them so often because of the larger costs associated with them in the form of premiums. In today’s world, every business thinks of reducing and cutting costs and in my opinion, this is the main reason behind that firms do not prefer to buy and hold long-term options, and moreover, they do not have any more tolerance for paying higher premiums. These are the reasons firms avoid buying and holding long-term currency options and mostly utilize other techniques of hedging. We can conclude from the above that primarily due to the high premium costs on long-term currency options (while keeping all the other factors constant), companies are in a better position to avoid such costs.

Net profit / unit (on call) = Exercise price + Premium – Spot Rate

= $0.71 + $0.02 - $0.70

= $0.03

Net profit / unit (on put) = Spot rate + Premium – Exercise price

= $0.70 + $0.03 - $ 0.75

= $-0.02

As the speculator has taken short position on call option i.e. at $1.50. Thus, the premium of $0.02 will be received.

In case Euro’s spot rate $1.55 today and the options are exercised

Option payout = $1.55 - $1.50

= $0.05 ( Cash payment)

And, the net loss would be = $0.05 - $0.02

= $0.03

If in case the Euro’s spot rate $1.48 today, options would not be exercised

Thus, the premium of $0.02 received would be the profit.