Philadelphia Stock Exchange Takes the Guesswork Out Of Foreign Exchange
Posted on 02/20/2008, 07:22
By Dana Nicholas
As the value of the U.S. dollar continues to decline, investors are starting to wonder how they can use foreign exchange to take advantage of the weakening dollar. New currency products from the Philadelphia Stock exchange may be just what investors are looking for.
In the past, the buying and selling of currencies has been dominated by central banks, large investment firms, and wealthy investors. Foreign exchange products have simply been too costly, too speculative, and too confusing for the average investor.
No more! In July of this year the Philadelphia Stock Exchange (PHLX) launched a group of new currency products that opened up the world of foreign exchange to investors from all walks of life. Unlike other currency products that require a very large cash outlay, the innovative new World Currency Options have been “down-sized,” making them affordable to even the smallest of investors. This gives everyone – including you – the chance to participate in the worldwide currency markets.
The most appealing aspect: The entire investment risk is limited to the premium cost and brokerage fees, which can run as little as $100 for a single contract. This makes it easy for those who have never traded currencies to enter the market with minimal risk.
Trading PHLX World Currency Options is Easy
The idea of buying an option on a currency may sound a little bit intimidating. After all, the words “option” and “currency” appear in the same sentence … and many investors have never traded either. But the concept behind these products is extremely straightforward. They are very easy to understand, simple to calculate, and can be traded right in your regular brokerage account. These exchange traded options are structured very similar to index options, and their value is simply the current trading price of the currency, multiplied by 100. So if the Euro is currently trading at 1.379 (quoted as EUR/USD 1.379), the PHLX would show it as 137.9.
The currencies covered include the Euro, Japanese yen, British pound, Canadian dollar, Swiss franc and the Australian dollar. The underlying contract size for each currency is 10,000 units (except the yen, which is 1,000,000 units.) So when you purchase one contract, it is worth 10,000 units of the underlying currency. If you expect the Euro to strengthen against the U.S. dollar, you might want to purchase a call option on the Euro. Call options are used when you expect the underlying currency to rise.
Here’s a quick example of a trade:
Let’s say the Euro is trading at 1.337 and you purchase a call option for a premium of .65 with a strike price of 135.5 (EUR/USD 1.355). This means you are expecting the Euro to rise above 1.355. Once the Euro surpasses the strike price, the option is “in the money” and can be sold at a profit. So if the Euro were to reach 136.9 (EUR/USD 1.369) before the contract expired, the proceeds from the sale would be $140.
Since the contract size is 10,000 units, a 100 multiplier is used to calculate the profits:
Proceeds from sale
Euro at time of sale: $136.9
Less Strike Price: -$135.5
$ 1.4 X 100 = $140.00
Less Cost of Option (premium)
$ .65 X 100 = $ 65.00
Profit $ 75.00
If you expect the Euro to decline against the U.S. dollar, you might want to purchase a put option. Put options are used when you expect a currency to decline in value during the life of the option contract. So if the Euro is trading at 1.33, and you were to purchase a put option with a strike price of 131, you would be expecting the Euro to drop below 1.31 before the contract expires. If it were to decline to 1.29, for example, the profit would be $200 prior to deducting the premium ($131 minus $129 times the 100 multiplier). Before you begin trading in currencies …
Prior to selecting a currency option to purchase, make sure you have a basic understanding of the principals involved. If you expect a currency to rise in value, there should be a firm reason behind that expectation – whether it is based on your own research or the advice of a trusted source. Also, bear in mind that currencies are directly related to the economic and political environment of a country. Inflation, interest rates, elections, and political instability can all play a role in the direction a currency will move.
So take time out to research and gain a basic understanding of these issues prior to purchasing a put or call option on a specific currency. If you’ve ever wanted to dabble in currencies, this is the perfect vehicle to test your skills. The small investment sizes limit your risk, while giving you the opportunity to take advantage of the same profit opportunities the big players have been realizing for years.
For more information on World Currency Options, visit the Philadelphia Stock Exchange at http://www.PHLX.com/market/worldcurrencyoptions.asp