Is the upside payoff unlimited for buying a FX call option?
Hi guys,
I understand that the upside payoff for buying a equity call option is unlimited. But is the upside payoff also unlimited for buying a FX call option?
Thanks, Derek
The mechanics behind the options are the same, regardless of what asset class they are tied to. In theory there is unlimited upside, but in reality you most likely have counterparty risk.
This is incorrect, upside is not unlimited depending on the fx direction and there is convexity at play for large moves If your account is in usd terms.
Imagine you buy 10 million of a usd/mxn option with a strike of 25. If usdmxn explodes and goes to 50. You bought 10mm usd/mxn at 25 when you execute so you’re now long 10mm usd short 250mm pesos. When you buy back those 250mm pesos 250mm/50 = 5mm in pnl
Now if usd/mxn went from 25 to 1000, the 250mm pesos you are short is 250k in usd terms, so your pnl is 9,750,000. As you can see, your max pnl in usd terms is capped by the notional amount of the initial trade. This works in opposite direction for puts where your loss in usd terms is unlimited and convex
This is mostly an issue in EM where blowups happen often, much less important in g7 but still a factor
I disagree. The value of the option itself has unlimited upside, in theory. To use your example: If usd/mxn went to 10,000, or 1,000,000 the contract would still increase in value. The answer would then be that the value of the option itself is unlimited-notional investment, which is still unlimited. I'd show it mathematically, but I'm lazy and tipsy.
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