EURO OPTIONS: BUYING CALLS
All of the popular foreign currency pairs can be traded in the futures and options markets.
For example, let's say that you are bullish on EUR/USD, meaning the Euro-U.S. dollar exchange rate.
The EURO/USD exchange rate is the price of one Euro in U.S. dollars. To be bullish means that you expect
this rate to rise, in other words, that you expect the Euro to strengthen against the U.S. dollar or,
alternatively, the U.S. dollar to weaken against the Euro. You are watching the March 2010 EUR/USD futures
and expect prices to break through $1.5000 and to move higher over the next few months. (See chart at right.)
To profit should this happen, you are considering buying a call option on the EUR/USD futures.
The first step of the
purchase decision
is to determine the maturity of the call option: it must be long enough to capture the anticipated price rally.
Since you suspect that prices will move higher over the next several months,
you decide that the
March 2010 EUR/USD call options that
expire in
early February
are a good choice. The second step is determining the strike price.
March EUR/USD call options are available across a wide range of strike prices, each having a different cost.
(See table at right.)
Reading EUR/USD Option Prices
EUR/USD options are priced
in dollars per Euro up to four decimals. One EUR/USD option can be exercised into one
EUR/USD futures contract and since each contract is based on 125,000 Euro, the option price must be
multiplied by 125,000 to get a corresponding dollar value and every one cent change in the price of the option or the underlying
futures for that matter is worth $1,250 per contract.
For example, the March EUR/USD call option struck at 1495 (or $1.4950 per Euro) settled at 0.04040 meaning $0.0404 per Euro.
The dollar value of this option is $0.0404 x 125,000 = $5,050. This call option is at-the-money
since the March futures contract settled the day at $1.4961 per Euro. Notice that the futures closed
higher over the day by $0.0118 taking all call option prices higher as well but that the option prices moved by less
than this amount. In fact, this at-the-money call option rose by just $0.0050 per Euro.
As is evident in the table, as the strike price of a call option is raised,
its price declines
as does its sensitivity
to movements in the price of the underlying futures.
Choosing the Strike Price
This requires balancing risk with potential return. The former is simply the cost or purchase price of the option
along with brokerage commission and other trading fees. For example, if you want to risk at most no more than $2,500
on a March EUR/USD call option, then only those options having a strike price of 1545 (or $1.5450 per Euro) or higher would be acceptable.
The potential return is based upon your expectation of how far EUR/USD prices will rally. A useful reference is the
break-even price.
The break-even price of a call option
is calculated by adding the option cost and paid trading fees to the strike price.
Consider, for example, the March EUR/USD call option struck at 1510 (or $1.5100 per Euro). If it is
purchased at the settlement price shown, then the break-even
price of the March futures at option expiration is calculated as:
1.5100 + 0.0330 + fee value = 1.5430 + fee value.
At option expiration, March EUR/USD futures must be above this break-even price in order to
profit on the option trade.
So, you will only consider call options that have a break-even price below the price to which you expect
EUR/USD will rally. Let's say, for example, that you believe March EUR/USD can reach $1.5600 per Euro by option expiration.
Based on this, you would only consider buying call options having a strike price of 1535 (or $1.5350 per Euro) or lower
since otherwise the break-even price is too high.
What remains is the range of acceptable options. In this case, for an investment of at most $2,500 and with an expectation that March
EUR/USD will rally to $1.5600 per Euro by option expiration, there are no acceptable call options to purchase.
So, you can consider buying a more expensive call option and manage the risk, or
you can consider buying a bull call spread.
Bull Call Spread
When buying a bull call spread, both strike prices should be below the price to which
you anticipate the futures will rise by the time the options expire, in this case, $1.5600 per Euro. Based on this, there are several spreads
that can be purchased. For example, the 1540/1550 bull call spread has a value of 0.0213 - 0.0183 = 0.0030 = $375 plus commission and fees.
If March EUR/USD futures is above $1.5500 per Euro at the time of option expiration, then this spread will close
at its maximum value of $1,250 (calculated as one cent x $1,250 per cent). If EUR/USD is below $1.5400 per Euro,
then this spread will expire worthless.
Stepping down the strike prices will increase marginally the cost of the spread, but the chance of the maximum value
being earned is greater since EUR/USD need not rise so far. For example, the 1530/1540 bull call spread has a value
of 0.0247 - 0.0213 = 0.0034 = $425 plus commission and fees. March EUR/USD need only be above $1.5400 per Euro at the time of option expiration
to earn the $1,250 maximum value of the spread. If EUR/USD is below $1.5300 per Euro, then this spread will expire worthless.
As you can see, spreads can be constructed at relatively little expense. You can risk more on a spread in return for greater
potential payout by increasing the gap between the two strike prices. For example, the 1530/1550
bull call spread has a value of 0.0247 - 0.0183 = 0.0064 = $800 plus commission and fees but the maximum value is $2,500
and will be earned if March EUR/USD futures is above $1.5500 per Euro at the time of option expiration.
Because the market for option spreads is generally less active than the market for individual options,
you will likely have to pay a slightly higher price in order to effect the purchase. After the purchase,
you will need to manage the option spread position.
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(See also our site on Forex Education.)
March 2010 EUR/USD Futures
Settle on Nov 23, 2009: $1.4961 Change: +$0.0118
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March 2010 EUR/USD Call Option Prices
Prices as of Nov 23, 2009. Source: CME Group
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You can also trade call and put
binary options on the Euro for as
little as $30. Learn more.
Interested in EUR/USD Options?
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