A foreign exchange put option gives you the right to sell foreign currency. As in the case of call options, put options can be used by MNCs and speculators alike. An American exporter may have account receivables in a foreign currency. In this case, the exchange rate risk is a possible depreciation of the foreign currency and the MNC would like to hedge against this risk.
If you are a speculator, you plan to buy foreign currency at a cheaper price at the future spot market and sell it at a higher price on the put option. As an MNC or a speculator, a put option locks you in a minimum exchange rate to be received in the future. As in the case of the call option, your benchmark for exercising the put option or not is the future spot market. If the spot exchange rate is lower than the exercise price, the holder of the put option exercises the option to sell currency on the put option.
If the future spot rate is higher than the exercise price, the holder of the put option lets the option expire without exercising it. For example, a U. The American exporter has future receivables in euros and faces the risk of depreciation in the euro.
The exchange rate risk faced by the American exporter is depreciation of the euro. If in fact the euro depreciates in the future spot market, the American firm will exercise the put option and sell the euros at a higher rate on the put option. Therefore, the firm lets the put option to expire. In terms of speculating with put options, your goal is the same: Using a put option, you are planning to buy currency cheaper at the future spot market and sell it at a higher price on the put option.
You must have an expectation of depreciation of the foreign currency. Suppose you expect depreciation of the euro in a month. The expiration date is a month from now. Now you let the put option expire. Your selling price corresponds to the exercise price at which you sell currency on the put option. The premium that you paid upfront and the spot exchange rate at which you buy currency are subtracted from the exercise price.
In this case, your per-unit loss is:.More...