I’ve fielded quite a few questions lately about World Currency Options (WCOs), with several different factors driving people’s interest. For some folks, oil’s slide and the emerging-markets drop has gotten them thinking about those markets' relationships to the surprisingly plucky dollar. Others are following the foreign reaction to the now-international financial crisis and wondering about ways they can trade on their predictions. Still other folks are looking for a hedge for dollar-denominated savings or income – or just plain looking for a change-of-pace from one of the craziest equities markets in decades. Whatever the reason, now seems like a good time to dig into World Currency Options, or WCOs. If you’re developing predictions about where various currencies are headed next, options traders can put those predictions into action immediately – without the hassle of opening a separate futures / currency trading account.
Both the Philadelphia Stock Exchange (PHLX) and the International Securities Exchange (ISE) offer U.S. dollar-settled world currency options, also known as FX options. Both exchanges do a solid job of describing their respective products, so I’d encourage you to check out both the links above for more info. Check out the PHLX webinars and ISE webinars, too, for even more detailed trader education. Currencies coverage on Seeking Alpha’s blogger network is also pretty comprehensive.
If you’re already familiar with options, these products will likely be pretty familiar to you, so you can start trading more or less immediately with minimal friction. The key concept to grasp is the answer to this question: how do you translate your currency predictions into a specific WCO play? What does a buying a call or a selling a put in this context mean? The PHLX’s FAQ puts the answer pretty nicely:
“For call options you would be forecasting that the foreign currency would strengthen vs. the U.S. dollar during the life of the option contract. For put options your forecast would be for the foreign currency to weaken vs. the U.S. dollar during the life of the option contract.”
So, to answer my own hypothetical question: if you’re bearish on the dollar and bullish on, say, the yen, you might express that sentiment by buying a call on that pair. If your feeling was reversed, you might buy the put.
For all you hedgers: don’t forget that these options, like all options, eventually expire – evaporating your hedge after expiration. If you’re looking for cover, make sure you’ve included that fact into your hedge calculations before diving in.
If you have any specific questions or come across any other useful reads on this topic, please share with the group here! I’m glad to get the discussion going on this one.
Regards,
Brian (OG)
[image: Yes by mike (el madrileño) on flickr]
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.
While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.
Any strategies discussed or securities mentioned, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities.
Please be aware that early assignment of short options on American style expiration options may affect the overall max profit and loss potential of the strategy. Please plan accordingly for this possible occurrence.
