Foreign Exchange
Financial Engineering
Hedge Currency Payables with a Purchased Reverse Knock In Call
• Unlimited Benefit if Currency Depreciates
• Upfront Cost Lower than Regular Call Option
• Unhedged Range Determined by Hedger
Profile of a Reverse Knock In Call Option
to Hedge Currency Payables
Product Description
A call option with a reverse knock in allows a buyer the
right, but not the obligation, to buy a fixed amount of one
currency for another at a set strike price on a specific
future date. The option does not become effective,
however, unless spot reaches the predetermined knock
in trigger. The premium of a call option with a reverse
knock in costs less than a premium for a regular call
option with the same strike. Unlike a knock in whose
trigger event occurs out-of-the-money, the reverse knock
in must be in-the-money when the trigger event occurs.
0
P & L+
Loss Protection Range with
Reverse Knock In Event
Benefit Range
Unhedged
Range
Trigger Strike
Call Strike
Payable & Hedge
Currency Payable
Foreign Currency
+
Currency Payable with Trigger Event
The buyer of a call is not obligated at any time to buy the
underlying currency. If spot never reaches the reverse
knock in trigger prior to expiration, the holder of the call
can buy currency at the current market. However, if spot
trades at or below the trigger before expiry, the option
becomes effective with all the characteristics of a regular
call option.
Reverse Knock In Call Options as a Hedge
A holder of a currency payable would purchase a call
option with a reverse knock in to hedge against a
currency’s appreciation while allowing for unlimited
benefit from the currency’s depreciation. In exchange
for a reduced premium, the buyer assumes the limited
risk that the currency may appreciate up to but not touch
the trigger. If a trigger event occurs, the value of the call
will immediately offset the negative move in the currency
exposure below the strike at expiration, less the
premium