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Currency options are derivative contracts where foreign currency is the underlying asset. Currency options are also known as forex options or fx options. The contract is between a buyer and a seller. The contract gives the buyer the right (and not the obligation) to buy or sell the underlying foreign currency at a specified price on an agreed upon date in future.
Currency options are of two types: Call options and put options. The buyer of a call option has the right to buy the underlying currency at an agreed upon price at a future date.
A put option provides the buyer the right to sell the underlying asset.
For exercising the right to trade the underlying asset, the seller of the option is a paid a price known as a premium. The price that is specified for either buying or selling at the future date is known as the strike price.
When an investor believes that the US dollar will appreciate against the Euro, he purchases a currency call option on USD/EUR. If the value of the US dollar actually increases against the Euro, the buyer can exercise his right to earn a profit.
• They are extremely useful for hedging against the adverse movements of exchange rates.
• These are the only options which are traded 24 hours a day.
• Currency options change value very frequently, since they are tied to the volatile forex market.• The small outlay that is paid as the initial margin may prevent an investor from estimating the actual losses that he may suffer due to adverse market conditions.
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