Introduction

The composite option is designed for investors who: 

- want to execute an option strategy on a foreign stock

- want to fix the strike in their own currency

- get the payout of the option in their own currency

 

In contrast to the quanto option, the holder of a composite option has exposure to the FX rate. 

 

One of the reasons that a composite option is traded is to protect the value in their own currency on a foreign investment. 

 

Example: 

US investor owns GSK stock (GBP). 

- GSK stock = 13£

- FX rate = 2 USD/GBP      --> $ value of one share = 26$

 

To protect this holding, he buys 1Y ATM compo put on GSK @ strike = 26$. 

 

After 1Y, stock goes down to 11£ and the FX rate goes from 2 USD/GBP to 1.5 USD/GBP. 

The $ value of GSK has gone down from 26$ to 16.5$. 

 

Because the strike price of the compo option is fixed in $, the $ loss on the shares is totally offset by the payout of the compo put option. 

 

In summary, the holder of a compo option wants to protect the share value in his own currency to both FX rate movements and stock price movements. 

 

 

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