Foreign Currency Options: Quotation, Valuation, and U.S. Dollar Cash Settlement
A U.S. multinational corporation anticipates receiving a payment of 5,000,000 British Pounds (GBP) in six months and wishes to hedge against the depreciation of the British Pound relative to the U.S. Dollar. What exchange-traded option contract should the company purchase, and in what currency does exercise settlement take place?
To hedge against a declining foreign currency, buy Put options on that currency. All exchange-traded foreign currency options settle in U.S. DOLLARS on T+1.
Complete Analysis & Legal Rationale
To protect against a decline in the value of the British Pound, the company should purchase British Pound Put options (giving the right to effectively sell GBP at the strike price). In the U.S., exchange-traded World Currency Options (traded on the PHLX/Nasdaq) settle exclusively in U.S. DOLLARS (not physical foreign bank notes) on the next business day (T+1). If the pound drops below the strike price, the holder receives cash in U.S. Dollars equal to the intrinsic value multiplied by the contract size.
Distractor Autopsy (Why Other Options Are Traps)
FINRA exam writers design incorrect distractors using specific calculation mistakes and regulatory misconceptions. Review why each option succeeds or fails:
Calls protect against currency appreciation, not depreciation, and physical currency is not delivered.
Puts hedge against falling currency values, and contracts settle in U.S. Dollars on T+1.
Commodity delivery like gold is not used for standardized currency options.
Buying Euros does not hedge British Pound receivables, and U.S. dollar settlement is the mandatory standard.
Official Standard: Specifies cash-settlement in U.S. Dollars for standardized foreign currency contracts.