One way is to buy a put option on the US Dollar so that your downside risk is limited to the premium paid. Alternatively you can also create a synthetic put option by combining a futures and a call option in the same strategy. For example, if you expect the dollar to weaken further versus the rupee, you can sell the USD-INR futures at Rs.72 and also simultaneously buy a 72 call option on the USD-INR strike 72 at a premium of say Rs.0.30. How will the payoffs look like in this case?

Sell Futures

72.00

Prem

N.A

Strategy

Synthetic Put or Protective Call Option

Buy ATM Call

72 Strike

Prem

0.30

Sell 72 futures and buy 72 call

Break Even

Once option cost is covered over the cost of Futures

Price

Sell Futures

Call Strike

Call Premium

Break Even Cost

ITM / OTM

P/L on Futures

P/L On Call

Overall P/L

68.00

72.00

72.00

0.30

71.70

OTM

4.00

-0.30

3.70

68.50

72.00

72.00

0.30

71.70

OTM

3.50

-0.30

3.20

69.00

72.00

72.00

0.30

71.70

OTM

3.00

-0.30

2.70

69.50

72.00

72.00

0.30

71.70

OTM

2.50

-0.30

2.20

70.00

72.00

72.00

0.30

71.70

OTM

2.00

-0.30

1.70

70.50

72.00

72.00

0.30

71.70

OTM

1.50

-0.30

1.20

71.00

72.00

72.00

0.30

71.70

OTM

1.00

-0.30

0.70

71.50

72.00

72.00

0.30

71.70

OTM

0.50

-0.30

0.20

72.00

72.00

72.00

0.30

71.70

ATM

-

-0.30

-0.30

72.50

72.00

72.00

0.30

71.70

ITM

-0.50

0.20

-0.30

73.00

72.00

72.00

0.30

71.70

ITM

-1.00

0.70

-0.30

73.50

72.00

72.00

0.30

71.70

ITM

-1.50

1.20

-0.30

74.00

72.00

72.00

0.30

71.70

ITM

-2.00

1.70

-0.30

74.50

72.00

72.00

0.30

71.70

ITM

-2.50

2.20

-0.30

75.00

72.00

72.00

0.30

71.70

ITM

-3.00

2.70

-0.30

75.50

72.00

72.00

0.30

71.70

ITM

-3.50

3.20

-0.30

76.00

72.00

72.00

0.30

71.70

ITM

-4.00

3.70

-0.30

76.50

72.00

72.00

0.30

71.70

ITM

-4.50

4.20

-0.30

77.00

72.00

72.00

0.30

71.70

ITM

-5.00

4.70

-0.30

In the above case, the break even for the synthetic put will be Rs.71.70 because at that cost your cost of the future and the cost of the call option of Rs.0.30 will aggregate to create your break even. Below this level, your profits are unlimited as you are short on USD-INR futures, and irrespective of how much higher the dollar goes, your maximum loss will be limited to Rs.0.30 only. Here are a few key inferences that you can draw from this above table.

· The breakeven point is arrived at by deducting the cost of the put option to the cost of the short futures sold. Below this point we can be profitable and the profits are unlimited below 71.70.

· This strategy is a good strategy to help you make money on the weakening of the dollar or the strengthening of the rupee. However, at the same time your risk of rupee strengthening is also covered in this case.

The question is what would have happened had we purchased a 73 strike call option instead of a 72 strike call option. What will be the trade off in this case? Let us check it out.

Sell Futures

72.00

Prem

N.A

Strategy

Synthetic Put or Protective Call Option

Buy ATM Call

73 Strike

Prem

0.05

Sell 72 futures and buy 73 call

Break Even

Once option cost is covered over the cost of Futures

Price

Sell Futures

Call Strike

Call Premium

Break Even Cost

ITM / OTM

P/L on Futures

P/L On Call

Overall P/L

68.00

72.00

73.00

0.05

71.95

OTM

4.00

-0.05

3.95

68.50

72.00

73.00

0.05

71.95

OTM

3.50

-0.05

3.45

69.00

72.00

73.00

0.05

71.95

OTM

3.00

-0.05

2.95

69.50

72.00

73.00

0.05

71.95

OTM

2.50

-0.05

2.45

70.00

72.00

73.00

0.05

71.95

OTM

2.00

-0.05

1.95

70.50

72.00

73.00

0.05

71.95

OTM

1.50

-0.05

1.45

71.00

72.00

73.00

0.05

71.95

OTM

1.00

-0.05

0.95

71.50

72.00

73.00

0.05

71.95

OTM

0.50

-0.05

0.45

72.00

72.00

73.00

0.05

71.95

OTM

-

-0.05

-0.05

72.50

72.00

73.00

0.05

71.95

OTM

-0.50

-0.05

-0.55

73.00

72.00

73.00

0.05

71.95

ATM

-1.00

-0.05

-1.05

73.50

72.00

73.00

0.05

71.95

ITM

-1.50

0.45

-1.05

74.00

72.00

73.00

0.05

71.95

ITM

-2.00

0.95

-1.05

74.50

72.00

73.00

0.05

71.95

ITM

-2.50

1.45

-1.05

75.00

72.00

73.00

0.05

71.95

ITM

-3.00

1.95

-1.05

75.50

72.00

73.00

0.05

71.95

ITM

-3.50

2.45

-1.05

76.00

72.00

73.00

0.05

71.95

ITM

-4.00

2.95

-1.05

76.50

72.00

73.00

0.05

71.95

ITM

-4.50

3.45

-1.05

77.00

72.00

73.00

0.05

71.95

ITM

-5.00

3.95

-1.05

In the above case, the break even for the synthetic put will be Rs.71.95 because at that cost your cost of the future and the cost of the put option of Rs.0.05 will aggregate to create your break even. Below this level, your profits are unlimited and irrespective of how much higher you go your maximum loss will be limited top Rs.1.05 only. Here there is something confusing! In the previous illustration, our max loss was limited to the premium, then why is it higher here? That is because the strike price is Rs.1 higher than the futures price. So your maximum loss is (Rs.1 difference + 0.05 premium paid on option). Here are a few key inferences that you can draw from this above table.

· The breakeven point is arrived at by deducting the cost of the put option from the cost of the future sold short. Below this point we can be profitable and the profits are unlimited below 71.95. The strike price of the call does not in any way impact the break even; that is still calculated by deducting the premium cost from the futures price at which the dollar is sold short.

· This strategy is a good strategy to help you make money on the weakening of the dollar or the strengthening of the rupee. However, your downside risk is slightly larger in this case but your upside profits are also benefited and is also covered in this case.

You need to choose the strike price for the call option 72 or 73 based on your view of the USD Rupee and the volatility you see. Ultimately, it is a trade off.