I’m in an international finance class and I need to write a paper about the yen and whether I would recommend purchasing futures or options in the yen. I’ve read all the chapters in the text and looked up articles and I still don’t get it. If the exchange rates are changing and the dollar is worth less than the yen in a month than it is now, how can you profit? Should you buy or sell futures if I think the yen will appreciate? I need someone to ELI5.
In: 1
Perhaps just from a trading perspective you are stuck on the idea that you can buy and sell both put and call options.
Your reading might also refer to the two purposes of futures and options speculation and hedging. If you are trading for client maybe they might be looking to get rid of price risk associated with changes in exchange rate.
An example:
You make a contract allowing you to buy yen in the future at a fixed rate.
If the yen gains in value against the dollar (exceeds the rate you bought at), you will have net gains in dollar after exchanging the yen bought on the spot market.
Naturally, profitability depends on option/future pricing, since it make little sense if you pay an exorbitant sum for the contracts
First, terminology. For future contracts you can go long or short (like stocks). For options you have calls and puts (essentially long and short).
If you look at the 6J futures contract, it’s the dollar against the yen. At the moment it’s around 0.76. that’s means, roughly speaking, for every $.76, you get 100 yen (which is about $1.00 when you spend it in Japan). This isn’t quite accurate though as futures contract calculations are more complicsted. Forex spot prices are closer to real world exchange rates.
So if you think the yen will increase in value, you will buy futures long on 6J.
For futures you have to consider the expiration dates. When the contract expires, you have to close the contract, take delivery on the goods, or roll it over to the next contract. For trading you’d likely just roll it over.
I don’t trade futures options so I’m not 100% sure, but I think it’s similar to stocks where you can buy an options contract to control 100 futures contracts at a time. But options is much more complicated in the way it works and is calculated compared to futures, so I won’t get into it here. But basically for an option, if you think the yen will go up, you will buy a put. You kinda have to figure out at what price you think the futures contract will be and when (like .9 in 3 months), as it will affect the price of the option. And the cheaper the option the more you can buy (for more potential profit). Once the options hit it’s contract expiration date, it’s either worthless (didn’t hit the strike price. In our example .9) or has value. Something like 90% of options contracts expire worthless.
The one major advantage of options you only lose what you put in. So if you bought $1000 worth of 6J futures options today, and the contract tanks to .5, you’d only lose the $1000. For futures you win/lose based on the tick value, theres no cap.
Let’s say you are going on vacation to Japan in 6 months and someone in Japan is coming to the US for a vacation 6 months. Neither of you really know what the exchange rate will at that time, neither of you have the money now but you want to start planning. You find this person and agree on a rate to swap you money at in 6 months.
Now…it is not easy to find that person but a bank can and will charge BOTH of you a fee to act between both of you, decide what the rate will be and handle the transaction.
How does the bank decide the rate? The bank deal with LOTS of people and if more people want Yen in 6 months then the rate for the Yen will go up. If less people want Yen in 6 months then the rate will go down.
You are given the bank a fee (few percent) to get a fixed rate some point in the future.
How can you make money off of this? Let’s say TODAY you agree with the bank buy 1,000,000 YEN for $10,000 on Feb 2, 2023.
If in 6 months on Feb 2, 2023 the ACTUAL exchange rate is 110 YEN for each $1USD you buy the 1,000,000 YEN for $10,000USD. You then take the 1,000,000 YEN and then exchange it back to $9,090.91USD and lose $909.09 USD (less bank fees).
If in 6 months on Feb 2, 2023 the ACTUAL exchange rate is 90 YEN for each $1USD you buy the 1,000,000 YEN for $10,000USD. You then take the 1,000,000 YEN and then exchange it back to $11,111.11USD and gain $1,111.11 USD (less bank fees).
Latest Answers