Someone was explaining this to me, was hoping sombody could clarify:
Say you have a 1year call on usd/jpy (i.e. call on usd, put on jpy). Strike is say 100.
In 9 months time, spot is say at 120. If you wanted to sell the option, you have 2000 jpy points of intrinsic value and let's assume 20 points of time value. So you can receive 2020 jpy points if you sell the option.
If you want to exercise, you can buy spot at 100, immediately sell at the prevailing rate of 120, earning 2000 jpy points. You then roll your position by buing dollars forward for 3months (why are we doing this rolling??). Let's say forward points are -16, so you can buy dollars 3 months forward at 99.84. So you have actually "earnt" 16 jpy points by rollowing it forward (??). Hence in this case the "forward value" being greater than the time value of the option means you would exercise.
He said because you want to hold the underlying is the reason you "roll" the position forward. I thought simply the value of that early exercise was whatever the intrinsic value turned out to be (2000 jpy points in this case) ?
He went on to say that "there comes a point in the life of an American option, where exercising the option and holding the underlying to the expiry date is actually more advantageous than holding the option to the expiry date. So it's important to compare (and that's why you roll the spot forward) the return on the two available options if you held them over the same time horizon".
If anyone could help elaborate on this i would be grateful!