What is Structured Options ?
A Seagull Option is a Structured Option which allows you to hedge your exposure. It involves three (3) Option legs with the risk usually lower than the level of a standard Forward. However, as a trade-off, your protection is capped at a pre-determined level. If the exchange rate moves against you and is worse than your Maximum Protection Rate, you will be obliged to deal at an adjusted spot rate. The adjusted spot rate is the current spot rate +/- the difference between your protection and Maximum protection rate.
Key Risks and Benefits
Key Risks of Using a Seagull Option Include:
- The Protection is limited. Should there be a large market swing against the hedging requirement, you may be required to deal at the adjusted spot rate;
- Similar to a Forward, if the market moves against the trade position, due to the Maximum Participation Rate, the position could be Out-of-the-Money (OTM), and you are obligated to deal at a less favourable rate as against the prevailing spot rate.
Key Benefits of Using a Seagull Option Include:
- Allows Participation for a favourable rate up to the Maximum Participation Rate.
- It still allows you to have risk exposure protection, albeit in a reduced amount or scale of points.
Key Features Summarized
- Risk Profile: Low
- Downside Risk Protection: Yes – Limited
- Upside Participation: Yes
- Enhanced Rate on Strike: No
- Allowing Predelivery: No
Trading Example
As an Australian exporter who exports raw materials to South East Asia, you are expecting USD 3,000,000 paid by your overseas customers in the next 12 months. You have a cost rate at 0.7400 but you can re-negotiate a better pricing term with the customers should the AUD/USD go above 0.7700. You believe the AUD/USD might fall, and you want to participate if there is a drop in the AUD/USD spot rate below 0.7000.
Therefore, you consider the following Seagull Option:
- Protection Amount: Selling USD $3,000,000 into AUD
- Protection Rate: 0.7400 Maximum
- Protection Rate: 0.7700
- Participation Rate: 0.6700
- Expiration Date: 12 months
Structure Details
- Buying an AUD Call/USD Put, strike at 0.7400, Notional USD $3,000,000; Expiring in 12 months.
- Selling an AUD Call/USD Put, strike at 0.7700, Notional USD $3,000,000; Expiring in 12 months.
- Selling an AUD Put/USD Call, strike at 0.6700, Notional USD $3,000,000; Expiring in 12 months.
Outcome at Expiration Date (12 months)
- Outcome 1: At Expiry, if the spot rate is between 0.7400 and 0.7700, you can choose to sell USD $3,000,000 at 0.7400;
- Outcome 2: At Expiry, if the spot rate is above 0.7700, you will sell USD $3,000,000 at the prevailing spot rate less 300 points (adjusted spot rate);
- Outcome 3: At Expiry, if the spot is below 0.7400 and above 0.6700, the option structure lapses, and you can sell at the prevailing market spot rate which is better off than the Protection Rate;
- Outcome 4: At Expiry, if the spot is at or below 0.6700, you are obligated to sell USD $3,000,000 at 0.6700.
Payoff Diagram
