Quantity-Adjusting Option (Quanto Option)

What Is a Quantity-Adjusting Option (Quanto Option)

A quantity-adjusting option, otherwise called a Quanto option, is a cash-settled, cross-currency derivative, where the underlying asset is designated in a currency other than the currency in which the option is settled.

One more name for these options is a guaranteed exchange rate option. Quanto options come in both call and put varieties.

Understanding Quantity-Adjusting Option (Quanto Option)

Quantity-adjusting options get their name from its potential currency forward nature, with a variable notional, or abstract, amount. Subsequently the term "quantity changed" or "Quanto," for short.

Investors use Quantos when they accept a specific asset will truly do well in a nation however dread that country's currency won't perform too. Accordingly, the investor will buy a option in the foreign asset while keeping the payout in their home currency.

How Quanto Options Work

World markets are unstable elements. Vacillations might make one currency trade higher or lower than one more at some random time. If a U.S.- based investor were to invest straightforwardly in a foreign stock index, they would open themselves to risks in that foreign index as well as risks due to the variances in the currency exchange rate.

A side benefit of a Quanto option is to make greater liquidity in more modest or riskier markets by eliminating currency risk for overseas investors. Reduction of risk empowers participation in these markets.

Quantos are settled at a fixed rate of exchange, giving investors shelter from exchange-rate risk. At the hour of expiration, the option's value is calculated in the foreign currency and afterward changed over at a fixed rate into the domestic currency.

Both the strike price and underlying asset are valued in the foreign currency. At the hour of activity, calculation of the option's intrinsic value is in the foreign currency. This foreign currency value is changed over completely to the investor's domestic currency at the fixed exchange rate.

Types of Quantity-Adjusting Options

Quantos are fabricated the same way as traditional equity options. The critical difference is that it is purchased in the investor's domestic currency, while named in the asset's foreign currency. At origin, the Quanto contract fixes the exchange rate between the two currencies. This fixed exchange rate stays in force however long the contract would last.

There are extra types of quantity-adjusting options an investor might buy. One sort of Quanto futures contract is the Nikkei 225, which is traded on the Chicago Mercantile Exchange (CME Group). The underlying asset for the futures contract is the Nikkei 225 Stock Index. The contract is settled in U.S. dollars, rather than in Japanese yen.

There are likewise Quanto swaps accessible. In a swap, one of the counterparties pays a foreign interest rate to the next party, while the notional amount is in the domestic currency.