Currency Call Option

Meaning

Currency Call Option is a contract between two parties under which option buyer gets the right to buy the underlying currency within a specified period.

For buying the ‘right’, call option buyer will pay an amount to call option seller that is called premium.

The call option buyer will make profit if the price of the underlying currency will increase.

If on or before the expiration date, price of the underlying currency falls below the strike price, the maximum loss a currency call option buyer will bear would be the premium amount.

Payoff and Profit at The Expiry of Currency Call Option Contract

Call Option Buyer’s Perspective

The call option buyer will exercise his right only if he is in profit that means he will exercise his right only when market price is more than strike price.

Call Option Buyer’s Payoff: – Market Price (Spot Price) – Strike Price

Profit/Loss for Call Option Buyer: – Market Price – Strike Price – Premium

Call Option Seller’s Perspective

Call Option Seller’s Payoff: –    -Market Price (Spot Price) – Strike Price

Profit/Loss for Call Option Seller: –   -Market Price – Strike Price – Premium

Example

An Indian importer will pay £10,00,000 within 60-days for importing solar equipment from UK (Britain). Importer anticipates that £ price in terms of Rupee may increase in future. Therefore, he decided to enter into currency call option contract. Following are the details –

Strike Price = ₹ 94.50

Premium = ₹ 2

Spot Price 1£ = ₹ 98.51 after 60 days

Ans: –

The importer has bought a call option, therefore he has right to buy £ (Currency) at ₹ 94.50 (Strike Price). At the expiry of the contract spot price of the £ is ₹ 98.51.

As the importer can get the £ at a lower price as compare to market (spot price), he will exercise his right and, in this case, payoff would be₹ 40,10,000 [£10,00,000 * (98.51 – 94.50)].

Therefore, profit would be ₹ 20,10,000 [£10,00,000 * ((₹ 4.01 – ₹2 (premium))]. In this example you can see, how importer hedged himself by currency call option and also earned profit of ₹ 20,10,000.