Currency Chapter Notes

Chapter 4: Exchange Traded Currency Options

NISM Series I — Currency Derivatives | ~11% weightage | ~70 questions

What this chapter is about

Currency options work exactly like equity options — same Greeks, same moneyness concepts, same payoff logic. If you've done CH4 of Series VIII, this is largely review with one critical difference: the underlying is an exchange rate instead of a stock price. The exam tests the same traps (selling call = obligation to SELL not buy), the same breakeven formulas, and the same volatility logic. Master this chapter and it compounds with Series VIII knowledge.

Key concepts

Call option — right to BUY the underlying (currency pair) at the strike price. Buyer is bullish on the underlying (expects USDINR to rise = expects USD to appreciate).

Put option — right to SELL the underlying at the strike price. Buyer is bearish (expects USDINR to fall = expects INR to appreciate).

Only European style options on Indian exchanges — exercise only on expiry date. Both OTC and exchange-traded currency options in India are European.

Lot size same as futures — USDINR = 1,000 USD, EURINR = 1,000 EUR, GBPINR = 1,000 GBP, JPYINR = 1,00,000 JPY

Premium settlement — option premium is cash-settled in INR upfront (buyer pays, seller receives). Quoted in INR per unit of base currency.

Expiry time — 12:30 PM on expiry day (same as futures). Trading stops at 12:30 PM.

Operating range for options — based on DELTA of the option (not a fixed ±3% like futures).

Moneyness

Intrinsic value = amount by which option is ITM (minimum zero, never negative)

• Call intrinsic = max(Spot − Strike, 0)
• Put intrinsic = max(Strike − Spot, 0)

Time value = Option premium − Intrinsic value

Option value = Intrinsic Value + Time Value ← tested as True/False constantly

Breakeven points

Call buyer breakeven = Strike + Premium paid
Put buyer breakeven  = Strike − Premium paid
Call seller breakeven = Strike + Premium received
Put seller breakeven  = Strike − Premium received

Example: Buy USDINR call at strike 84, pay premium 0.35 Breakeven = 84 + 0.35 = 84.35 You start profiting only when USDINR > 84.35

Sell USDINR put at strike 84, receive premium 0.40 Breakeven = 84 − 0.40 = 83.60 You start losing only when USDINR < 83.60

Payoff summary

Option writer (seller): Always limited profit (premium), potentially unlimited loss.

Option pricing factors

Key rule: Higher volatility = higher premium for BOTH calls and puts. Volatility measures magnitude of price movement (direction-neutral).

Option pricing models

Black-Scholes — analytical, faster, used for EUROPEAN options

Binomial model — iterative (uses repeated calculation), more flexible, used for AMERICAN options. More computing power required, more accurate but slower.

Greeks (lightly tested in currency vs heavily in equity)

Delta — rate of change of option price per unit change in spot. Used to determine operating range for currency options (unlike futures which use fixed ±3%).

Vega — sensitivity to volatility. Higher volatility → premium rises.

Theta — time decay. As time passes, premium falls (benefits seller).

Complex P&L calculation — exam favourite

Example: USDINR spot = 75. Buy 1 lot put at strike 75.50, pay premium 0.28. Sell 1 lot call at strike 75.25, receive premium 0.35. Expiry settlement = 75.50.

Put (bought): Strike 75.50, settlement 75.50 → exactly ATM → zero intrinsic value. Loss = premium paid = 0.28 × 1,000 = Rs 280 loss

Call (sold): Strike 75.25, settlement 75.50 → ITM for buyer → seller pays (75.50 − 75.25) = 0.25. Net = 0.35 received − 0.25 paid = 0.10 × 1,000 = Rs 100 profit

Net = Rs 280 loss − Rs 100 profit = Rs 180 net loss

Real market example

An Indian IT company will receive USD 10 lakh in 3 months. They fear INR might appreciate (USDINR might fall from 84 to 82). They buy USDINR put options at strike 84, paying premium Rs 0.40 per USD.

Cost of hedge = 0.40 × 10,00,000 = Rs 4,00,000

If USDINR falls to 82 at expiry:

• Without hedge: convert at 82 → Rs 8.2 crore
• With hedge: exercise put at 84 → Rs 8.4 crore, minus Rs 4 lakh premium = Rs 8.36 crore
• Saved: Rs 16 lakhs

The hedge worked. This is how exporters use put options.

Trap Alert

Trap 1: "Selling a call = obligation to BUY" — FALSE Selling a call = obligation to SELL (deliver) the underlying to the buyer if exercised.

Trap 2: "Selling a put = obligation to SELL" — FALSE Selling a put = obligation to BUY (take delivery of) the underlying from the buyer if exercised.

Trap 3: "Buying a put = right to buy" — FALSE Buying a put = right to SELL. Only buying a call = right to buy.

Trap 4: "American options are traded on Indian exchanges" — FALSE Only European options on Indian exchanges (both OTC and exchange-traded in India are European).

Trap 5: "ATM premium > ITM premium for same tenor" — FALSE ITM premium > ATM premium > OTM premium (ITM has intrinsic value).

Trap 6: "Volatility only affects call premium, not put premium" — FALSE Higher volatility → higher premium for BOTH calls AND puts.

Must-remember rules

• European options only on Indian exchanges
• Option value = Intrinsic Value + Time Value (ALWAYS)
• Intrinsic value = never negative (minimum zero)
• Call breakeven = Strike + Premium | Put breakeven = Strike − Premium
• Sell call = obligation to SELL | Sell put = obligation to BUY
• ITM premium > ATM > OTM (same tenor)
• Higher volatility → higher premium (both C and P)
• Black-Scholes = European | Binomial = American (iterative)
• Operating range for options = based on Delta (not fixed %)
• Option buyer: limited loss (premium) | Seller: limited profit (premium)
• OTC and exchange-traded currency options in India = both European

Weightage note

~11% = ~70 questions. Heavy on True/False traps around call/put rights and obligations. Breakeven calculations appear 2-3 times per exam. Complex multi-leg P&L (buy put + sell call type) appears 1-2 times. Option pricing factors (volatility, time) are standard True/False questions.

Quick revision — 60 second scan

• Call = right to buy | Put = right to sell
• Sell call = SELL obligation | Sell put = BUY obligation
• European only on Indian exchanges
• Breakeven: Call buyer = S+P | Put buyer = S−P
• ITM > ATM > OTM (premium order)
• Higher volatility → higher premium (both C and P)
• Black-Scholes = European | Binomial = American
• Option value = Intrinsic + Time value (never negative intrinsic)
• Operating range = Delta-based (not fixed ±%)