Currency options

DEFINITION of currency options

Currency options are a type of options contract that gives the holder the right, but not the obligation, to buy or sell a currency pair at a given price before a set time of expiry.

WHAT IT IS IN ESSENCE

To get this right, the holder of the option pays a premium to the seller (known as the option’s writer).

Currency options give investors the right to buy the underlying Currency Future.

Put Options give them the right to sell it.

Investors are required to pay a premium for the choice of exercising the Option or not.

The premium is calculated based on the volatility of the underlying exchange rate.

There are two kinds of currency option: calls and puts.

A call option gives the holder the right to buy a currency pair at the strike price before the expiry date. While a put option gives the trader the right to sell a currency pair at the strike price before the expiry date.

If at the time of expiry, the market price of your chosen pair is above (calls) or below (puts) the strike price of your option, you can choose to exercise it. And buy (calls) or sell (puts) the currency for a better price. Better than what is currently available on the market.

But if this never transpires, you can let your option expire. And only lose the premium that you paid for the option in the first place. 

HOW TO USE

Currency options are popular among forex traders because they are a great help to protect against loss and speculate for profit. Buying an option to sell a currency pair that you have an existing long position on provides that if its price falls, you can limit your losses by exercising your option and selling at a more favorable price.

If its prices rise you can simply let the option expire.

But if you don’t have an existing position on a currency pair but you hope for its price in the near future, you can buy a call option and lock in a guaranteed price to buy that pair. As long as the pair’s price rises above the strike by more than what you paid as the premium, your option will earn a profit.