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Equity-Linked Foreign Exchange (Elf-X) Option
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#Equity-Linked Foreign Exchange (Elf-X) Option (3 graphs) An elf-X put option enables an investor to sell a foreign stock position or portfolio at a future date (the expiration date of the option contract) without risk of foreign exchange loss. Specifically, 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 will provide the right to buy enough currency at the strike exchange rate to purchase a specified foreign equity position without fear that foreign currency appreciation will increase the cost of the position in the investor's home currency. While elf-X puts and calls provide currency protection, the price of the stocks can move against an investor while the elf-X option is in place. The principal, or face amount of the option, is a function of the future value of a specific underlying equity portfolio, not a fixed amount set at the time the option is purchased. One difference between the quanto and the elf-X option is that the exchange rate is fixed at the spot rate with a quanto, and the option payout in the investor's base currency is dependent on the equity or index percentage return in the equity's natural currency. If the equity or index percentage return is not in the money in the position's natural currency at maturity, there is no quanto option payout, regardless of the currency change. In contrast, the elf-X option has no payout if the exchange rate does not change in the direction required under the terms of the put or call option. For example, an elf-X put on dollars relative to sterling has no payout if sterling depreciates relative to the dollar. The option will pay out if sterling appreciates, but the size of the payout is also a function of the performance of an underlying equity portfolio or index. If the portfolio appreciates, the payout will increase in proportion to the portfolio value. Also called Portfolio Currency Protection Option (PCPO). Compare with Quantity Adjusting Option (QUANTO) (1).
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