Option "Premium" Pricing

Dear All,

I was hoping you could shed some light for me on how the "premium" is calculated on a currency option....

for example, i have been quoted by XYZ Bank

Currency Options

XYZ Buys USD 200,000
XYZ Sells GBP

Expiry Date: 28 Sep 2009
Value Date: 30 Sep 2009

Indicative Prices - To protect a rate of £/$ 1.40 (Strike Rate) the cost would be £8,715

So this is based on a "vanilla" option, which i assume is a call option on USDGBP - the only pricing i have seen available online for such cash settled OTC Options is at http://www.nasdaq.com/asp/currency-options.asp

on this page, as at "now" they are quoting a price of 7.60 for sept 09 USDGBP with strike of 1.400

How on earth do i get from "7.6" to an "option premium" price, i dont mind if its rough&ready just so that I get an indication of how they have arrived at the figure.

All your help is very much appreciated.

Vikas Shah

The price of an option is made up of intrinsic value (how much in-the-money the option is), time to expiration (greater the time, greater it is worth) and volatility. They probably use the Black-Scholes pricing model. You need to read up on options before even thinking about trading them.

that is the premium! 7.6.

thank you for the response, i know the "premium figure" is "7.6" however, i am trying to understand how bank gets from that figure to the actual cost they were going to charge me, eg: £8,715.00

i am not 'trading' options (i, as you say, am a believer that one should be fully knowledgeable in a product before trading). This is for a corporate requirement. We normally cover fx with spot/forwards, but we are starting to add options into the mix, and I dont like taking the banks "quote" at face value, i would much rather have my own method for arriving at a figure to corroborate what they provide.

You need to multiply the premium by the number of contracts (or shares) that you will be controlling. Options are quoted in the lowest common denominator.

thank you, so using my previous example..

Strike Puts Last Chg Bid Ask Vol

140.00

@XBXUH 5.00 7.20 7.60 0

on that basis, i am assuming the "premium multiplier" as it were, will be 100x (ie: percent)....

so, if i wanted to buy a put option on putGBP callUSD on the above basis for call200,000 usd, the rough premium i would expect to pay would be..

200,000 x 7.60% = usd15,200 (c. gbp10,000)

is that right?

i know i am asking a fairly difficult question here as most pricing would be calculated using brown-scholes or binomial models... but if there is a rough & ready method to doing this, it would be good to see it....

vikas

I can only explain this in terms of forex options cleared by the OCC and in terms of USD. If you get a quote of $7.60 and want to control $10,000 in currency you would pay $760.

To trade forex options you give up the leverage that you enjoy in the spot market. I don't think it makes sense to buy deep in the money options when you get spend less in the spot market.

You can sell that option and pocket ~ $760.

LOL, if you're a dumbass then yes, you could do that.

you could even use that 760 as margin on another option!

I do not know about you but I'm selling:
Jun 09 Call @ 152
Jun 09 Put @ 135.5

Unlimited risk on both sides - nice move. Why not just short it in the spot market and not use a stop? Either way requires the same amount of intelligence - none.

Yes c cool