Selling Foreign Exchange Call Options - dummies

Selling Foreign Exchange Call Options

By Ayse Evrensel

When you sell a call option, you are selling the right to buy foreign currency. Therefore, you no longer have an option. The buyer of your call option has the option to buy currency from you. In other words, you become the seller of foreign currency.

You collect the premium, but need to accommodate the decision of the buyer regarding exercising his option. The buyer decides whether to buy foreign currency from you, and you don’t have any say in the matter.

Suppose that you sell a call option on MXN1,000,000 with a premium of $0.0014 per unit and an exercise price of $0.083. The expiration date is a month from now.

If the future spot rate of $0.086, the buyer exercises the call option and buys pesos from you on the option contract. Of course, you have to sell pesos to the buyer. In this case, you have to buy pesos at the future spot market at $0.086 and sell them for $0.083. In terms of revenues, you lose $0.003 per peso. In terms of your payoff:

profit/loss = selling price – buying price

In the case of the seller of a call option, the selling price consists of the addition of the exercise price and the premium. Because the seller buys the currency at the spot market, the buying price is the spot exchange rate:

profit/loss = (exercise price + premium) – spot exchange rate

Using the previous example:

Profit/loss = $0.083 + $0.0014 – $0.086 = –$0.0016

Note that the buyer’s loss is limited to the premium, and his profits are unlimited. You, the seller of a call option, face unlimited loss, and your profits are limited to the premium.