What is a CURRENCY OPTION?
A CURRENCY OPTION is a financial instrument for hedging against risks that may arise from potentially negative developments in a currency pair. It also gives clients the possibility of profiting from positive developments in the forex market. When buying CURRENCY OPTIONS, the client has the option to buy or sell the given currency at a pre-agreed exchange rate on a specified future date. To obtain this option, the buyer of the currency option pays the seller a so called option premium.
What are the benefits of a CURRENCY OPTION?
A CURRENCY OPTION allows clients to secure their funds against unfavourable changes to exchange rates, as is the case of a forward transaction
. Unlike a forward transaction, the client can choose not to use the option and implement the trade on a given day for a better spot rate than the fixed rate would be. In this way, clients can participate in favourable rate developments.
- When buying a CURRENCY OPTION, the client is not required to lodge financial collateral. Instead, the buyer pays a non-refundable option premium.
- When selling a CURRENCY OPTION, the client is required to lodge financial collateral and in this case they collect the premium.
Variants of CURRENCY OPTIONS
- Call option - gives the holder the right to purchase the primary currency (the first currency in a currency pair) for the secondary currency (the second currency in a currency pair) at a predetermined rate in future.
- Put option - gives the holder the right to sell the primary currency for the secondary currency at a predetermined rate in future.
Variants according to settlement
- American option - the option holder has the right to exercise the option at any time between the date of agreement and the date of expiration.
- European option - the option holder has the right to exercise the option only on the day of expiration.
Conditions for acquiring a forward contract: