How does the Options market work and can you use a lifelike example of a put / call position which is relatable?
In: Economics
You can see Options as a “price guarantee” for something you want to buy / sell in the future, but you want to agree on the price in advance.
**Put Option Example**: You are an American company and get a contract from an EU company. You’ll get the payment of one million EUR for your work in one year. Today, 1 EUR is roughly 1.10 USD, but you don’t know what the exchange rate will be in a year.
If you want to “insure” that exchange rate, i.e. make sure you really get 1.1 million USD in a year, you can buy a put option on the EUR/USD exchange rate. A put option on EUR/USD with a strike of 1.10, expiring in one year and a total contract of 1 million EUR will guarantee that you at least get the 1.1 million USD in one year. This put option gives you the right, but not the duty, to sell 1 million EUR and receive 1.1 million USD in return. If the exchange rate were to rise, then you just let the option expire (i.e. you don’t exercise your right), and do the exchange at the current rate.
**Call Option Example**: For this job above, you’ll need a part from a Canadian company which costs 100k Canadian Dollars (CAD). Today, that’s 75k USD. You’ll need that part in 6 month, which is also when you’ll pay the Canadian company. Again, if you don’t want to gamble with the exchange rate, you’ll get a call option on the USD/CAD at strike 1.33 (current rate), expiry in 6 months, total contract of 100k CAD. The Call Option gives you the right, but not the duty, to buy 100k CAD for 75k USD in 6 months.
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