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To: Mark Adams who wrote (41214)	11/10/2003 6:51:46 PM
From: macavity	Read Replies (1) \| Respond to of 74559

A little knowledge....(is dangerous) Quick option lesson for (FX) traders. The future-valued cost of an at-the-forward straddle is 0.8 x sigma. sigma = vol x sqrt(time) So for a 1 year at-the-forward call the cost is (0.4)x10.00% = 4% of nominal at 10.00 vol in 1 year. This is not an NPV value - you have to discount it back The forward is such that it is actually not at the same level as spot. So the NPV price is actually a little less than this, but also the NPV of the yield differential is reduced. On economics I make it up as I go along, but on this stuff I do know a little bit. Trust me there is absolutely no arbitrage here - The carry trade is an FX bet with a yield kicker! These guys only 'look' clever when they make money i.e. when the FX change is negligible, or in their favour. You take on the FX risk to get the yield differential. Carry trade: Borrow in USD Deposit in EUR EURUSD = 1.1500 EUR = 3% USD = 1% Vol = 10% 1 year option protection against Dollar Appreciation EUR/Put-USD/Call = 3.46% of EUR Notional. The price of the option does reduce as EURO rates rise, due to the discounting effect and the fact that the forward gets further away from the option strike = today's spot level. So in this example it costs more than the yield differential. If EUR rates = 5% then the NPV cost is 2.57%. -macavity