Page 134 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 8: Currency Futures and Currency Options

For example, if the share is worth ` 60, the put is worth ` 40. Notes
Value of put option at expiration = Exercise price – Market price of the share
` 100 – ` 60 = ` 40

8.5.2 Option Categories

Options can be categorised in two ways:

1. According to the type of leakage exhibited by their underlying assets: Many securities that
underline option contracts pay dividend or interest and since the prices of listed options
are affected by these intervening capitalisation changes, the securities are said to exhibit
leakage.

Accordingly, these option instruments are classified as:
(a) Zero Leakage Option Instruments. These are options written on assets paying no
dividends or interest and having no substantial storage costs. Options falling under
this category are:
Gold Options: Gold pays no dividend or interest and its storage costs are
nominal.
Stock Options: Depending on either the firm’s dividend pattern (some firms
do not pay dividend) and the option’s maturity (options written on a dividend
paying stock may expire prior to stock’s next ex-dividend date), certain stock
options have zero leakage.

(b) Discrete Leakage Option Instruments. These are options derived from underlying assets
which exhibit an intervening cash flow that is continuous. Options in this category
are:
Stock Options

Stock Index Options: In the US, stock index options traded on SP100 and NYSE
composite index are very popular. SP100 is an index of many individual stocks
that pay different dividends throughout the year but the index itself exhibits
discontinuous leakage as most stock dividends are paid out during certain
months/days.

(c) Continuous Leakage Option Instruments. These are options derived from assets exhibiting
a continuous intervening cash flow. Options in this category are:

Currency Options: Foreign exchange can be used to purchase interest bearing
foreign assets thus generating a continuous leakage as determined by foreign
interest rate.

Future Options: A futures price exhibits a continuous leakage as the contract
matures and the spot and futures prices converge.

2. Options Based on Nature of Underlying Assets: Option instruments can also be classified
as:
(a) Options on Actuals: Stock options, stock index options, currency options and
commodity options.
(b) Options on Futures: i.e., futures options.

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