What is ‘Quantity-Adjusting Option – Quanto Option’
A cash-settled, cross-currency derivative in which the underlying asset is denominated in a currency other than the currency in which the option is settled. Quantos are settled at a fixed rate of exchange, providing investors with shelter from exchange-rate risk. At the time of expiration, the option’s value is calculated in the amount of foreign currency and then converted at a fixed rate into the domestic currency.
Explaining ‘Quantity-Adjusting Option – Quanto Option’
The CME Nikkei 225 is an example of a quanto. It is a futures contract for which the underlying asset – in this case, the Nikkei 225 Stock Average Index – is settled in U.S. dollars, as opposed to Japanese yen.
Investors use quantos when they believe that a security will do well in another country but fear that country’s currency will not. Thus, investors buy an option in the foreign stock while keeping the payout in their home currency.
Further Reading
- Quantity-adjusting options and forward contracts – papers.ssrn.com [PDF]
- Quanto European Option Pricing With Ambiguous Return Rates and Volatilities – ieeexplore.ieee.org [PDF]
- Model based Monte Carlo pricing of energy and temperature Quanto options – www.sciencedirect.com [PDF]
- A versatile approach for stochastic correlation using hyperbolic functions – www.tandfonline.com [PDF]
- Pricing and hedging quanto options in energy markets – papers.ssrn.com [PDF]
- Generalized put-Call parity – papers.ssrn.com [PDF]
- Cross market price support and agricultural development – www.emerald.com [PDF]
- The Incremental Expected Shortfall-Based Pricing: Application to a Cost-Effective Hedge of an Electricity Price-Volume Quanto Risk – papers.ssrn.com [PDF]
