What is a Currency Option?
Currency option is a contract which gives the buyer (holder) the right but not the obligation to buy or sell one currency against another. Options can be viewed very much as a form of insurance against exchange rate volatility. The buyer will still be able to benefit from favorable rate movements.
Currency Put Options
We do put options to limit an adverse fall in the market, while still able to take advantage of favorable rise in exchange rates.
It grants the holder the option but not the obligation to sell a fixed amount of currency at fixed rate and date in the future. The price of the option called the premium, which is paid in advance. Also, another element which is called the strike price. It is the exchange rate where an option holder can exercise his right. Finally the expiration date is the per-determined date on which the option contract expires.
Risks and Benefits
The main risk that the adverse exchange rate fall never materializes. In this case the put option is not needed. As the premium is already paid in advance, it can be compared to insurance premium.
Protection from an adverse fall in exchange rates is clear benefit of this product. Its important to realize that client will also benefit from a favorable rise in exchange rates.
Currency Call Options
Call options are done to limit an adverse rise in exchange rates, while we can still benefit from a favorable fall in exchange rates.
Call options grants the holder the right, but not the obligation, to buy a fixed amount of currency at a fixed rate at a certain time in the future. A part from this, the characteristics of a call are identical to those in put.
Risks and Benefits
Loosing premium is a main risk in taking a call option as adverse exchange rate rise never materializes. In this case protection is not needed, and as premium is been paid in advance. It can be compared to insurance premium.
Protection from an adverse rising in exchange rates is a clear benefit of a call option. Again client will also benefit from favorable fall in exchange rates.
Put and Call options can be tailor made to fit the exact client requirements in terms of exercise price, amount and term of the contract.
The majority of currency options are done in European style which allows the holder to exercise his right at the expiration date. Another form of options are done in American style options which allow the holder to exercise his right before the time of expiration.