The reason for the higher strike price becomes apparent on “From June to March” (below), which shows a proposed spread between the yen and the British pound. In the same way that the higher curve was bought and the lower curve sold in the previous example, June yen calls are bought and June pound calls are sold. Recall from the “Forex five” chart that yen calls are the most volatile and highest priced while the pound has the lowest curve. We expect the pound to have the speediest descent toward zero or intrinsic value.
Data for March on “From June to March” indicate that both curves are lower and that many of the strikes now show zero or near zero prices. It also shows that the collapse in the prices of yen and pound calls have brought those that are in-the-money closer to their intrinsic values. In establishing the spread trade between the yen and pound calls, we would like to have the strike price at an area in which the lower curve is pushed over, or close-to, the zero price while the higher curve still contains positive value.
The area of strike price selection is several percentage points above the current futures price. Above a futures price/strike price ratio of approximately 0.98, the intrinsic value is supporting the pound calls without giving more benefit to yen calls. Another way to express this is that at-the-money is a dangerous area because of gamma — the speed at which put and call prices change to higher delta values. Because the March yen curve is still the highest, it is losing the gamma contest to the pound calls.