Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Equity Linked Foreign Exchange Option

What it is:

An Equity Linked Foreign Exchange Option (or ELF-X) is a put option or call option that shelters an investor from foreign exchange risk. It enables an investor to sell a foreign stock position or portfolio at a future date (the expiration date of the option contract) without the risk of foreign exchange loss.

How it works (Example):

An ELF-X put gives the holder the right to sell the currency received on the stock sale at an exchange rate fixed in advance, usually the spot rate in effect when the option is created.

An ELF-X call position provides the right to buy enough currency at the strike exchange rate to purchase a specified foreign currency position without fear that foreign currency appreciation will increase the cost of the position in the investor's home currency.

For example, if an investor holds an ELF-X call option on U.S. dollar relative to Australian dollar, and the Australian dollar depreciates relative to the American, the investor would not receive a payout. However, if USD depreciates relative to AUD, the investor would receive the amount saved from use of the spot exchange rate in the option contract and the foreign-equity portfolio value, unless the premium paid for the call option.

Why it Matters:

Also known as the portfolio currency protection option, (or PCPO), this is a valuable tool for an investor in foreign equities who may have concerns over the value of his investment due to foreign currency fluctuations.