Non-Equity Options: Foreign Currency and Yield-Based
Most of what you've learned so far applies to equity options (options on individual stocks). But the Series 7 also tests two specialized categories: foreign currency options and yield-based (interest rate) options. Each has unique contract specifications and requires understanding the inverse relationship between yields and bond prices.
Foreign Currency Options
Foreign currency options give the holder the right to buy or sell a specific amount of foreign currency at a set exchange rate.
Contract Specifications
| Specification | Detail |
|---|---|
| Contract size | 10,000 units of the foreign currency (except Japanese yen: 1,000,000 yen) |
| Premium multiplier | 100 |
| Exercise style | European-style (exercise at expiration only) |
| Settlement | Physical delivery of the underlying currency |
| Expiration | Third Friday of the expiration month |
| Quotation | Premiums quoted in U.S. cents per unit of foreign currency |
Directional Logic
- A call on a foreign currency = right to buy the foreign currency
- Bullish on the foreign currency / bearish on the U.S. dollar
- A put on a foreign currency = right to sell the foreign currency
- Bearish on the foreign currency / bullish on the U.S. dollar
Commonly tested currencies: British pound, Canadian dollar, Australian dollar, Swiss franc, euro, Japanese yen
Remember: Foreign currency options settle in U.S. dollars, even though the underlying is a foreign currency. The settlement value is based on the Federal Reserve's 12:00 noon buying rate on expiration day.
Exam Tip: Gotchas
- Foreign currency options are European-style but settle by physical delivery. European-style means exercise at expiration only, yet unlike most European-style options, these settle with actual currency delivery (not cash).
- Japanese yen contract size is 1,000,000 (all other currencies are 10,000 units).
- Both foreign currency and yield-based options are European-style. This is an easy detail to overlook on the exam.
Yield-Based (Interest Rate) Options
Yield-based options are based on the yield (not the price) of U.S. Treasury securities. This distinction creates an inverse relationship that is frequently tested.
Contract Specifications
| Specification | Detail |
|---|---|
| Underlying | Yield on U.S. Treasury securities (13-week T-bill, 5-year T-note, 10-year T-note, 30-year T-bond) |
| Strike price | Represents a yield (move decimal one place left: strike of 35 = 3.5% yield) |
| Contract multiplier | $100 |
| Exercise style | European-style |
| Settlement | Cash settlement |
The Inverse Relationship: Yields vs. Prices
Since yields and bond prices move inversely, the directional logic is reversed from what you might expect:
| Position | Profits When | Equivalent Bond View |
|---|---|---|
| Long yield-based call | Yields rise | Bearish on bond prices |
| Long yield-based put | Yields fall | Bullish on bond prices |
- A long yield-based call hedges a bond portfolio against rising interest rates - as rates rise, the call gains value to offset bond losses
- A long yield-based put profits when yields fall (bond prices rise)
Exam Tip: Gotchas
- Yield-based options move with YIELDS, not prices. A long call on yield-based options profits when rates rise (opposite of a long call on a bond).
- "Call on yield = rates up = bond prices down." The exam specifically tests whether you understand this inverse relationship.
- Strike price of 35 on a yield-based option = 3.5% yield. Move the decimal one place left to convert.