What is an Equity Linked Foreign Exchange Option (ELF-X)?
An Equity Linked Foreign Exchange Option (or ELF-X) is a put option or call option that shelters an investor from foreign exchange risk. It enables an investor to sell a foreign stock position or portfolio at a future date (the expiration date of the option contract) without the risk of foreign exchange loss.
How Does an Equity Linked Foreign Exchange Option (ELF-X) Work?
An ELF-X call position provides the right to buy enough currency at the strike exchange rate to purchase a specified foreign currency position without fear that foreign currency appreciation will increase the cost of the position in the investor's home currency.
For example, if an investor holds an ELF-X call option on U.S. dollar relative to Australian dollar, and the Australian dollar depreciates relative to the American, the investor would not receive a payout. However, if USD depreciates relative to AUD, the investor would receive the amount saved from use of the spot exchange rate in the option contract and the foreign-equity portfolio value, unless the premium paid for the call option.
Why Does an Equity Linked Foreign Exchange Option (ELF-X) Matter?
Also known as the portfolio currency protection option, (or PCPO), this is a valuable tool for an investor in foreign equities who may have concerns over the value of his investment due to foreign currency fluctuations.