Quantity-Adjusting Option (Quanto Option)

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Definition of 'Quantity-Adjusting Option (Quanto Option)'

A quanto option is a type of option contract that allows the holder to exchange the value of an underlying asset for the value of a different asset, usually in a different currency. The exchange rate between the two currencies is fixed at the time the option is purchased.

Quanto options are often used to hedge against currency risk. For example, a U.S. company that exports goods to Europe may purchase a quanto option to protect itself against the risk of the euro depreciating against the dollar. If the euro does depreciate, the company will be able to exchange the value of its euro-denominated receivables for dollars at the fixed exchange rate, thereby locking in a profit.

Quanto options can also be used for speculation. For example, a trader who believes that the euro will appreciate against the dollar may purchase a quanto option to give them the right to buy euros at a fixed exchange rate. If the euro does appreciate, the trader will be able to make a profit by selling the euros at the higher market price.

Quanto options are typically more expensive than traditional options, because they involve two sources of risk: the risk of the underlying asset price moving and the risk of the exchange rate moving. However, they can be a valuable tool for hedging or speculation in situations where there is a high degree of currency risk.

Here are some additional details about quanto options:

* Quanto options are typically traded over-the-counter, rather than on an exchange.
* The exchange rate used in a quanto option is usually the spot exchange rate, but it can also be the forward exchange rate or the implied exchange rate.
* Quanto options can be either European-style or American-style.
* Quanto options can be used with a variety of underlying assets, including stocks, bonds, commodities, and currencies.

Quanto options are a complex financial instrument, and investors should carefully consider their risks before trading them.

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