Vanilla Options

A vanilla option provides the right but not the obligation to buy/sell a currency at a specified protected rate at a specific future date, while allowing the holder of the vanilla option to benefit from favourable movements in the market. A premium is payable on a vanilla option.

An example of how a vanilla option works

A UK-based company imports materials from the US and needs to pay a supplier $500,000 in six months’ time.

1. Requirements

The company:

  • would like to benefit from a favourable exchange rate and 100% rate protection
  • is willing to pay a premium for this

2. Current Forward Rate

The forward rate for a six-month period is

1.3300

 

3. Solution

The company buys a vanilla option for six months with a protected rate of 1.3250. The premium is

2.5%

There are two possible scenarios

Scenario 1:

Unfavourable market moves

GBP/USD weakens. At maturity, the exchange rate is 1.2500. The company is entitled to buy the full $500,000 at 1.3250.

Vanilla Options unfavourable market moves graph

Scenario 2:

Favourable market moves

GBP/USD strengthens. At maturity, the exchange rate is 1.4575. The company lets its vanilla option expire and simply buys $500,000 at the market rate of 1.4575, thus benefiting from the 10% improvement in the currency exchange rate.

Vanilla Options favourable market moves graph

Advantages of the vanilla option

  • Provides protection on 100% of the company’s exposure
  • Allows the company to benefit in full from favourable currency moves

Disadvantages of the vanilla option

  • A premium is payable and non-refundable

Key facts

  • Not subject to deposit and/or variation margins

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Disclaimer:

Option contracts are offered by Smart Currency Options Limited (SCOL) on an execution-only basis. This means that you must decide if you wish to obtain such a contract, and SCOL will not offer you advice about these contracts.

This material provides you with generic and illustrative information and in no way can it be deemed to be financial, investment, tax, legal or other professional advice, a personal recommendation or an offer to enter into an option contract and it should not be relied upon as such. Any changes in exchange rates and interest rates may have an adverse effect on the value, price or structure of these instruments.

SCOL shall not be responsible for any loss arising from entering into an option contract based on this material. SCOL makes every reasonable effort to ensure that this information is accurate and complete but assumes no responsibility for and gives no warranty with regard to the same.

Foreign exchange options can carry a high degree of risk and are not suitable for everyone as they can have a negative impact on your capital. If you are in doubt as to the suitability of any foreign exchange product, SCOL strongly encourages you to seek independent advice from suitable financial advisers.

Consulting a website or receiving a publication does not constitute a customer relationship and SCOL shall not have any duty or incur any liability or responsibility towards any person or entity as a result thereof.

SCOL is a wholly-owned subsidiary of Smart Currency Exchange Limited, and is authorised and regulated by the Financial Conduct Authority to carry out MiFID business with reference number 656427.

SCOL is a private company limited by shares registered in England and Wales. Company number 9034947. The registered office address is at 26-28 Hammersmith Grove, London W6 7BA.