More Options With More Options
By Chintan Kotecha, Nitin Saksena, Youssef Brahimi and Benjamin Bowler

Example 3: A Contrarian View On The Euro With Long FXE Call Options
The EUR/USD spot rate has declined as a result of increased risks in the eurozone over the last year and half (Figure 10). During this time, policymakers within the region have been coordinating to ensure the stability of the euro. However, given the risks still outstanding, a contrarian trade would be to go long the EUR/USD spot rate with the idea that the widespread European crisis will be averted.

A contrarian view on the EUR/USD spot rate could be implemented by purchasing FXE outright. However, a long FXE position has full downside exposure should the euro continue to decline. Instead, a call option on FXE would provide a limited-loss way to take advantage of upside in the euro. Figure 11 shows the profit and loss of a hypothetical at-the-money call option on FXE compared with purchasing FXE outright. In this example, we assume FXE is at $124, and the call option purchased is struck at-the-money for a cost of $1.00. If the euro appreciates, the call option participates in the upside (less the amount paid for the call option up front). If the euro continues its decline, however, the losses are limited to the upfront premium.

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