Options / Structured FX Transactions

Call

A buyer of a call option buys the right, but not the obligation, to buy a predetermined amount of a currency at a set strike price, on a predetermined expiry date. The buyer pays an upfront premium for this option. Similarly, a seller of a call option would be obligated to sell a certain amount of currency at a predetermined price, in exchange for receiving the upfront premium. Buying an outright call would be beneficial for a client who has a bullish view on a currency and wants to protect against a worst-case rate, while still maintaining full exposure to a weakening currency. The buyer does not require any credit for this transaction since the maximum potential cost is the premium paid up front. The seller of the call, faces little gain (the maximum being the upfront premium received) yet is fully exposed to the appreciating currency.

Put

A buyer of a put option buys the right, but not the obligation, to sell a predetermined amount of a currency at a set strike price, on a predetermined expiry date. The buyer pays an upfront premium for this option. Similarly, a seller of a put option would be obligated to buy a certain amount of currency at a predetermined price, in exchange for receiving the upfront premium. Buying an outright put would be beneficial for a client who has a bearish view on a currency and wants to protect against a worst case rate, while still maintaining full exposure to a strengthening currency. The buyer does not require any credit for this transaction since the maximum potential cost is the premium paid up front. The seller of the put, faces little gain (the maximum being the upfront premium received) yet is fully exposed to the depreciating currency.

Classic Vanilla Risk Reversal

A strategy where a call is bought and a put are sold (or vice versa) with the same expiry date and amount. Normally these are traded with common deltas, i.e.: 25 delta, or 15 delta, etc. The hedger receives protection at a certain pre-determined level that is financed by giving up participation past a pre-determined level.

Participating Forward

This strategy allows the hedger to lock-in a known worst-case rate while still allowing unlimited participation on a certain percentage of the hedged amount. A call is purchased against a put with the same strike and expiry but the notional on the put is a lower amount. Different participation rates can be structured according to the clients' risk appetite.

Seagull

This structure is designed to provide some protection against a depreciating currency, while also allowing for some participation in any currency strength (or vice-versa). It involves a combination of 3 options, buying an at the money call (put), and selling both and out of the money put and call. Note that while this trade does not provide a guaranteed worst-case protection, should the spot rate at maturity fall outside of the purchased out of the money option, the buyer does pick up the difference in the strikes between the atm and otm call (put).

Extendible / Extendible Flat Forwards

Typically, CIBC buys a specified amount of a currency for another at a fixed foreign exchange rate for a pre-determined amount of time. The client sells to CIBC the option to extend this transaction (typically) at the same FX rate. To compensate the client for this option, CIBC pays an above market rate for the currency amounts during the flat forward portion. This strategy is typically called a covered call. The client exceeds the current market rate for the flat forward (and) extendible portions of the trade. By employing the covered call strategy, the client should have the view that they would be "happy or indifferent" if they were to be exercised - and that they will always be exercised into a level that they could not have achieved in the market at the time of trading the extendible.

Average Rate

This is an option that is exercised against an average of observed spot rates rather than the terminal spot rate. Fixed interval averaging of the observations occurs at a predetermined frequency. The averaging process reduces exposure to the volatility of the spot rate so the cost of an Average Rate Option is typically less than a European Style option. Average Rate options are used by hedgers who are exposed to a risk relating to a consistent stream of cash flows over a period of time. These cash flows can be daily, weekly or monthly, for example. An illustration would be a company that gets paid for a product every day over a 1-month period for roughly the same amount. These receipts are then sold at the prevailing spot rate. An Average Rate option, with daily averaging, would protect the receipts since the rate received on selling the receipts would match the rate the option is exercised against. A European option would not provide a perfect hedge since the average price on the receipts would be different then the rate that the option is exercised against, namely spot at maturity of the option. Average Rate options are cash settled necessitating a spot transaction to convert receipts.

Average Strike

An Average Strike Option has a floating strike that is determined at expiry based upon the average rate for a pre-specified period, frequency and observation source. The average strike option is very similar to the average rate option, but in the average strike option the buyer does not know the strike until expiry. This option is useful for a company that would like to protect their budgeted rate, yet would also like to participate in any favourable currency moves. These options are cash settled and are useful for clients looking to hedge economic risk.

Compound

A Compound Option is an option on an underlying option with the strike of the Compound option being the premium of the underlying option. Four variations are available, a Call-on-a-Call, a Call-on-a-Put, a Put-on-a-Call and a Put-on-a-Put. The advantage of these structures is that they provide a less expensive way to hedge contingent cash flows, as compared to purchasing a vanilla option. The buyer of the option only buys the underlying option if it is in their best interest to do so. The drawback to these options is that if the compound option is exercised, the total premium is more expensive than a standard option if purchased.

Daily Digital Ranger

The Daily Digital Ranger is designed to take advantage of range bound markets by allowing for an improvement in the forward rate so long as spot remains within a designated range. For each day that spot sets outside the designated range, the initial forward rate is adjusted by a pre-set number of points, making the forward slightly worse. The outcome is uncertain, but a best and worst care scenario is known up front. There is potential for a worse rate than executing an outright forward if spot sets outside the range for more than a certain number of days.

Mini Premium

A Mini-Premium Option is a European option in which the purchaser only pays for the option if certain pre-designated triggers are touched up to the maturity of the option. If the triggers are not touched, the buyer of a Mini-Premium option has effectively purchased the option for zero cost. If all the triggers are touched, the Mini-Premium option will cost more than if the European option was paid for up-front. Unless otherwise noted, the underlying European option does not knock-out at the trigger levels. Mini-Premium options can be used by both corporate and investor accounts. Corporate hedgers can use a Mini-Premium option in place of a purchased European option as a standard hedging tool. If the triggers are not hit, the hedge will be zero cost. Investors can buy/sell Mini-Premium options in order to pay less or receive more premium than by buying/selling a European option.

Variable Rate Forward

A Variable Rate FX Forward is a hedging tool designed to provide protection at a known worst case rate while providing for an improvement in the forward rate if the spot exchange rate moves in the client's favor. This strategy is used by clients looking to hedge a specific date, much like a regular fx forward. The difference is that in a regular forward, the future rate is locked in and no improvement can be garnered from favorable movements in spot. The Variable Rate FX Forward provides for an improvement in the forward rate so long as spot does not touch a trigger level, set up-front. Thus, for a small give up over the outright forward rate, the hedger has the opportunity to significantly improve the potential forward rate.