As early as the ancient Greek and Roman periods, there was the use of the right to use with the concept of implicit option. Options were once again widely used in tulip trading in the Netherlands in the 17th century, but as the tulip market shrank, the options market also collapsed.

In the 18th and 19th centuries, relatively organized option trading appeared in Europe and the United States. However, the subject matter of the transaction was still mainly agricultural products. In the early 20th century, option trading was viewed as highly gambling. It was not until 1934 that the U.S. Securities and Exchange Commission (SEC) regulated option trading after the securities laws were implemented. At the same time, some brokers also organize an association (Put and Call Brokers and Dealers Association). Under the operation of this association, options trading has an over-the-counter quotation and trading network.

Since 1973, the options market has been growing at a very rapid rate; not only have various futures exchanges successively launched option transactions on various trading subjects, but also various countries have also established options trading markets. .

In the late 1970s, the theory of foreign exchange options gradually developed and took shape. The reason why the theoretical development of foreign exchange options is relatively late is that the issue of dealing with the interest rate between two currencies was not solved until the late 1970s. For all financial product options, the "parameters" of foreign exchange options are the most complex. The "parameters" of most options do not include interest rates and dividends, while stock options only include dividends. However, the parameters of foreign exchange options include the interest rates of two currencies, and its complexity is not difficult to imagine.

As far as the foreign exchange options market is concerned, options can be divided into two types: the first is the foreign exchange futures options market on futures exchanges, in which the options traded are traded on futures exchanges. The foreign exchange futures (Currency Futures) are the ontology, and the options derived from them. Its contract specifications, fluctuation range, transaction and delivery methods, margin calculation and settlement are all stipulated by the exchange. Trading of this foreign exchange futures option is limited to futures exchanges. The second type is spot foreign exchange options. The transaction of spot foreign exchange options is just like the spot foreign exchange transaction. The buyer and seller decide the amount, period, price and other contract contents by themselves, as long as the buyer and seller agree on the contents of the transaction. Generally speaking, the transaction of spot foreign exchange options is negotiated by the two parties themselves and does not go through any intermediary, so it is called the over-the-counter market (Over The Counter? OTC).

Option, as the name suggests, is the right for a holder to choose whether to perform a contract. People who buy options look at whether the purchased right can generate income through exercise at or before expiration. Let us use a simple example to explain the meaning of this sentence.

Today, suppose there is a person A. After careful analysis, it is determined that in the next three years, the real estate prices in a certain area of ????Guangzhou will have room to rise significantly, regardless of whether the purpose of the person A is to purchase property or invest. Financial management, he decided to seize this profit opportunity. Therefore, A can sign a pre-sale house contract with the developer of the area. After paying the signing fee, deposit, and project payment, he can obtain according to the pre-sale contract that after the completion of the future house, he will buy the house at a predetermined price now. Enter this house. This pre-sale contract is actually a very simple option contract.

In this pre-sale house contract, when the buyer and seller signed the contract, they pre-determined the amount of money that A should pay when the house is handed over at a certain point in the future (expiration date or settlement date) ( strike price). The subject matter of the contract is the property on a certain floor and in a certain unit designated by A. The deposit, signing fee, project payment, etc. paid by A are equal to the premium paid by A to buy the option. (Note: Nouns such as maturity date, exercise price, subject matter, premium, etc. are all important terms in options.)

The biggest benefit of options is that the party who buys the option has After paying the royalties, you gain the right to perform the contract, but do not have to bear the obligation to perform the contract. Just like in the example described above, A bought the right to buy a house he specified at a specific price in the future. If the real estate prices in the area really rise before the house is completed and handed over, A will naturally be willing to fulfill the contract and buy the house at the lower price originally agreed upon. However, if unfortunately the real estate prices in the area drop before the house is completed, A can choose to give up the right to buy the house, and the builder cannot require A to perform the contract. This is because what X purchased is a "right" rather than an "obligation". Of course, if Party A decides not to perform the contract, the royalties paid (deposit, signing fee, project payment, etc.) must be given up at the same time. Therefore, A will definitely take the royalties into consideration in the decision-making process of whether to sign this pre-sale house contract, or whether to perform or not to perform when the contract is completed and due. After going through such a process, Mr. A exchanged limited risk (loss of premium) for an opportunity with unlimited profit potential (increased housing prices).

So, in a business behavior that can often be seen in daily life, we can easily find the figure of choice.

In the future pages, we will use more examples to slowly lead you into the world of options. Then learn how to operate options in foreign exchange and other financial markets to gain more profit opportunities.

Its characteristics are small and large

In the previous article, we used the pre-sale house contract between the home buyer and the construction developer as an example to explain how to An investor's perspective looks at the opportunities presented by options.

In that example, person A who signed the contract obtained the right to buy a designated house at a predetermined price in the future after paying a royalty fee, while the builder received the right paid by person A. After receiving the payment, the house must be sold to Person A at a predetermined price in the future when Person A decides to fulfill the contract. What A's option (buyer) has is a right; and what the builder's option (seller) undertakes is an obligation. Although the details and trading rules of option trading are still quite different from this example, this has explained the investment nature of options.

So, what are the investment properties of options and what are the advantages of these properties? Simply put, using options as an investment tool provides the following benefits.

First, the option buyer has rights, not obligations. The buyer of the option, with the psychological support of expectations for a specific market, pays a premium to gain the opportunity to have unlimited profit potential if the market trend is favorable to him. This opportunity can be combined with a bullish view of the market outlook (call option) or a bearish view of the market outlook (put option).

In contrast, the seller of the option, after receiving the premium paid by the buyer, assumes the obligation to perform the contract at the buyer's request in the future. At first glance, it appears that the buyer of the option pays a sum of money and enjoys unlimited profit opportunities. The seller of the option receives a premium but must assume unlimited obligations. A normal person would wonder who would want to be the option seller? In fact, in mature markets, there are equal numbers of buyers and sellers of options, maintaining a fairly good market mechanism. As for the niche of option sellers, it is an advanced topic and we will explain it in detail in the future.

Second, buying options allows you to enjoy higher financial leverage (financing ratio). For example, if we want to buy a USD call option/JPY put option with a contract amount of US$1 million today, the premium we must pay may be as low as hundreds or thousands of US dollars, or as high as tens of thousands of US dollars.

The level of the royalty will, of course, depend on the terms of the option contract. But the important thing we need to understand now is that we can buy a large option contract for a relatively low premium. It is self-evident that option trading has the characteristics of small and large.

Third, option trading is suitable for both long and short positions and is suitable for various market conditions. By using option operations, we can not only go long or short, but we can also make profits during consolidation trends. Operators can even tailor a variety of option operation strategies based on your own risk tolerance and risk appetite. In the foreign exchange market that is already suitable for both long and short positions, option contracts bring more operating methods and flexibility.

The above three points are only a small part of the many features of option operations, and we only briefly mention them here. There may be some concepts and terms in the content that are not familiar to friends who invest in the foreign exchange market, but in this series, we will take you from the simple to the deep, from the most understandable stage, to move forward step by step, and become a foreign exchange option trading. The winner, stay tuned.

The hedging function is like life insurance

Options, from the perspective of avoiding investment risks, are like an insurance contract, providing operators with a mechanism to avoid position losses.

When investors expect market uncertainty to increase but do not want to close their positions, they can buy an option contract to protect the downside risk of their investment while maintaining future prospects. Profit potential and space. This and the insurance contract in real life are actually twin brothers.

For example, in real life, in addition to the purpose of saving, we will buy life insurance or accident insurance to protect us from the consequences of emergencies. Obtain a claim for personal injury. Under normal circumstances, the fact that we purchase life insurance and accident insurance does not mean that we expect these situations to happen to us in the foreseeable future. In fact, no normal person expects to receive a claim when buying insurance. After all, the prerequisite for getting a claim is that "an accident happened." Once the accident has happened, no matter how many claims you get, it will just make up for the shortcomings. Therefore, what insurance wants to protect is "uncertain" accidents. Because if an accident can be foreseen, how can it be considered an accident? If you know that the stock price will fall, you will end it by selling the shares, what kind of risk are you avoiding! ?

In fact, we can see the similarities between options and insurance industry terminology. In English, the term for insurance premiums is "Premium", and the term for option premiums is also "Premium". In the early years, some translators translated royalties as option "premiums", which was ridiculous and completely failed to convey the essential similarities between royalties and insurance premiums. From this similarity in terminology, we can also infer that the function of options in portfolio insurance is the same as that of life insurance and accident insurance for individuals.

Conceptually, an operator who wants to hedge a portfolio must "buy" options? Whether it is a call or a put. This principle is the same as the life insurance policy holder "buys" the insurance contract rather than "sells" the insurance contract. A hedger buys an option. If he wants to hedge a long position, he buys a put. If he wants to hedge a short position, he buys a call. When market conditions are unfavorable for his portfolio, he buys a call option. The profit from the transaction is used to make up for the loss of the original investment position. If the market does not change adversely to its investment position, the risk averter just pays a premium or premium to buy insurance (option).

More and more people will buy travel accident insurance when traveling. I believe that when they return home safely, they will not complain that they did not get a compensation claim because there was no accident during the trip! Similarly, for investors who use options, options provide a barrier to avoid market risks, and the price paid is the premium.

What is discussed in this article is only the concept of using options in hedging operations. The details of hedging operations require a deeper understanding of options before they can be described in detail.

Whether it is profit or loss, it depends on the orientation

We can think about the classification of options from several perspectives. First, classify options based on their directionality. Second, classify based on the performance method of options. Third, classify based on the value of options. Fourth, classify options based on the complexity of their conditions. Starting from this article, we will provide readers with a detailed introduction to each aspect of the option one by one.

Every financial instrument has operational directionality. If you hold a certain commodity, if the price rises in the future, the operator will make a profit; if you short a certain commodity, if the price falls in the future, the operator will make a profit. Short sellers can profit from this. But options do not determine the direction they represent in terms of buying or selling. In other words, if I only say that I bought an option, outsiders cannot know how the price increase or decrease of the underlying object in the future will affect my profit or loss. However, if I indicate that what I am buying is a call option or a put option, it is enough to express what the rise or fall in the price of the underlying asset means to me.

Options can be broadly divided into "CALL Option" and "Put Option". When Chinese people learn about options, they often have difficulty in learning because of the convoluted terminology between the buying and selling of call options and put options. It is recommended that everyone use the original text more often when learning about the right of choice, which will make it less likely to be confused. CALL means "call" or "request" in English, and represents a right to request or buy in the future. Put, in English, means "throw out" or "give up", which represents a right to give up or sell in the future. In a literal sense, you can clearly tell the difference.

The holder of the call option has the right to purchase the underlying object (Underlying) to the seller of the call option at a pre-agreed strike price (Strike Price) on a specific date in the future. So buying a call option locks in the price of a specific commodity in the future. If the price of the underlying asset rises before the expiration date and is higher than the strike price, the holder of the call option has the right to buy the underlying asset at the strike price and sell the underlying asset at the market price to earn the price difference. If the price of the underlying asset does not rise above the performance price as expected, the holder of the call option can choose not to perform the contract and allow the call option to expire and lose the original premium paid.

The holder of the put right has the right to sell the subject matter to the seller of the put right at a pre-agreed execution price on a specific date in the future. So buying a put option locks in the price at which a specific commodity will be sold in the future. If the price of the underlying asset falls before the expiration date and is lower than the strike price, the holder of the put option has the right to sell the underlying asset at the strike price and buy the underlying asset at the market price to earn the price difference. If the price of the underlying asset does not fall below the performance price as expected, the holder of the put option can choose not to perform the contract and allow the put option to expire and lose the original premium paid.

Therefore, we can see a simple principle from the basic properties of call and put rights. That is, when an investor is bullish about the market outlook, the operating strategy he should adopt is to buy (hold) a call option; when the underlying asset rises above the strike price before the expiration date, he will make a profit. When an investor is bearish on the market outlook, the operating strategy he should adopt is to buy (hold) a put option; when the underlying asset falls below the strike price before the expiration date, he will make a profit. This is the most basic operation strategy of options, and it also clearly distinguishes the difference between buying and selling options.

Currency pairing should be clear

In the previous article, we talked about the basic properties of call and put options. In this article, the characteristics and practices of call and put options in the foreign exchange market will be explained.

In the stock options or futures options market, the subject matter of call and put options is very clear. The subject matter of a stock option is a specific stock, while the subject matter of an option is a specific futures contract. However, in the foreign exchange market, you need to pay attention to clearly expressing the currency pair (Currency Pair).

In foreign exchange transactions, each exchange rate represents a change in the relative strength of two currencies.

For example, most people will talk about the change in the exchange rate of the Japanese yen, but in professional grammar, it should be said to be the change in the exchange rate of "USD against Japanese yen". Otherwise, just talking about the Japanese yen exchange rate, the ones traded in the international market are the euro against the yen, the pound against the yen and the Australian dollar against the yen. If the two currencies are not explained clearly, unnecessary errors and troubles may easily occur during the transaction. This is not a professional approach.

Therefore, in foreign exchange options trading, if you want to clearly explain the subject matter, you must explain the currency pairing. For example, if we believe that the trend of the U.S. dollar against the Japanese yen is obviously upward, and we want to use foreign exchange options as an operating tool, the action we need to do at this time is to buy the U.S. dollar and sell the Japanese yen, so the option we want to buy It is USD CALL/JPY Put. If you only know that you want to short the Japanese yen, and when you inquire with the bank where you placed the order, you ask about "JPY Put", or the trader I will quote you the price of USD call option/JPY put option based on intuition. But if you are actually looking at the exchange rate of the euro against the yen, then if you only ask the quoting bank for the price of the "yen put", you may get an incorrect quote.

Therefore, in order to conduct foreign exchange option transactions in the most professional and efficient way, you must first remember to clearly inform the quoter of the currency pairing for which the exchange rate is to be inquired.

There is a simple way to clarify these inquiry rules. First, determine which two currencies you are looking at. Then, decide which of the currencies you want to go long on (which is equivalent to going short on the other currency). Next, decide whether to use the buying option or selling option operation strategy (the operation strategy will be introduced in detail in the near future). Finally, make an inquiry to the quoting bank. If you choose a long option strategy, you can ask for quotes for long currency calls/short currency puts.

Let’s give a few examples to familiarize readers with when and how to inquire.

1. If a person believes that the exchange rate of pound against US dollar will fall, then he may want to establish a position of selling pounds and buying US dollars. At this time, he can buy a USD call/GBP put (USD CALL/GBP Put).

2. If A believes that the exchange rate of the euro against the pound will rise and decides to go long on the euro and short on the pound, then he can buy a euro call/GBP put (EUR CALL/GBP Put).

In this article, in order not to make it too complicated at once, the example of selling options will be omitted.

In short, in foreign exchange option trading, the operator must clarify the currency pairing of the option that he wants to inquire about. This is just as important as when new to foreign exchange trading, operators must understand the differences between direct quotations and indirect quotations, as well as the quotation conventions of each currency exchange rate. As for the basic definitions of call and put options, please refer to last week’s column for details.

American and European styles are different

In the classification of options, another important classification method is based on whether the option can be performed before the expiration date. We call those options that can only be exercised on the option expiration date European Options; those that can be exercised on the option expiration date or any day before expiration are called American Options. ).

Why are these two option contracts called European style and American style respectively? The reason is unknown. In the early days of the option contract, the simplest option contract stipulated that all performance actions could only be performed on the expiration date. However, as the complexity of the market increases, more and more operators require performance before the expiration date, so American options have become popular.

Basically, stock options, index options, futures options and other option contracts traded in centralized markets are all American options. However, option contracts traded in the over-the-counter market, such as foreign exchange options, interest rate caps and floors (Caps Floors), swap options (Swaptions), etc., are mostly European-style options.

Therefore, unless otherwise specified, banks quoting foreign exchange options will assume that the inquirer's inquiry is for European-style options, not American-style options. Therefore, generally speaking, when operating foreign exchange options, you should note that you can usually only request performance on the expiration date, but cannot request performance before the expiration date.

Perhaps you will be curious whether there are any obvious differences in the operation of European and American options, and whether one is better than the other under different circumstances.

According to financial theory, American options may be better than European options after taking into account certain special factors (such as cash dividends).

For example, when Company A suddenly announces a higher-than-expected cash dividend, holders of American options on the company’s stock can immediately request performance, convert the options into stocks, and receive the cash dividend. ; And those who hold the company's European options can only stare blankly, unable to perform the contract exchange for shares in advance and receive cash dividends. However, apart from this special factor and considering other conditions, we find that there is no advantage or disadvantage between American options and European options.

Intuitively, we would think that since investment options acquire rights, the more flexible the rights are, the more valuable they should be.

American options are more flexible than European options, which seems to be in line with such an intuitive idea. Many people believe that American options should be more valuable than European options. But in fact, after we explain how the value of options is calculated, you will know that, except for factors such as cash dividends, the values ??of American options and European options should be equal.

If you want to break it down further, in fact, between American and European options, there is a third type of options, which are Atlantic Options, or Bermuda options. Bermudian Options. From the words, you can easily tell that the performance terms of this option are somewhere between American and European (both the Atlantic Ocean and Bermuda are geographically between the American and European continents). For example, an option contract has an expiration date one year later, but can be performed early in the last week of each quarter (the contract can be performed on the expiration date, but there are still other restrictions on the date of performance). This is the most typical Bermuda options.

In order to adapt to the various needs of market participants, Financial Engineering (Financial Engineering) researchers continue to develop a variety of strange option clauses. However, in terms of restrictions on the time of performance, the above three types of clauses are generally inseparable. It can be said that everything changes without departing from its roots.