Currency options, also known as foreign exchange options, is a contract that grants the holder the right, not the obligation, to buy (call) or sell (put) currency at a specified exchange rate during a specified period of time.  It is the “exchange of money denominated in one currency into another currency at a pre-agreed exchange rate.” (www.investopedia.com)   To capture this right, the buyer must pay a premium to the broker, which varies depending on the number of contracts purchased.  Currency options is one of the best ways for corporations or e

According to the textbook, currency options is the one of the fastest growing segments of the global foreign exchange market. Currency options is a financial contact that give the buyer the right, but not the obligation , to buy or sell a specified number of foreign currency units to the option seller at a fixed dollar price, up to the option’s expiration date. Then there is the American option that can be exercised at any time up to the expiration date and the European option can be exercised only at maturity.

Currency Options are primarily used to deal with foreign financial contracts to purchase a specific amount of foreign currency at a specified fixed price. The seller of the option charges a premium to the buyer for providing the hedging service, even if the buyer chooses not to exercise their power to buy the currency at the expiration date of the contract. The premium is typically calculated as a percentage of the currency option price. There is specific terminology used to describe parties and actions involved with a currency option.

Currency option contracts are traded on the Currency Options Market (UCOM). They were first traded in Philadelphia. They were created out of the desire to eliminate some of the disadvantages that currency future contracts and forward contracts have. There are two kinds of options: the American option and the European option. The American option can be exercised (sold) at any time before maturity, while the European option can only be exercised on the date of maturity. Obviously the American option is more flexible and the one that speculative investors are more interested in.

Options can be used as arbitrary, speculation or hedging tools. This paper is dealing with the letter one, the hedging tool. First of all the author wants to explain what hedging contains. Hedging is generally a finance transaction as a safeguard against risks such as exchange rate fluctuations or changes of commodity prices. The person or company who wants to hedge a transaction, also called the Hedger, is doing another transaction which is directly linked to the underlying transaction.

When dealing with currency forecasting, there are four criteria. Forecasters must meet at least one to be successful. First, you must have an exclusive use of a superior forecasting model. Second, have consistent access to information before other investors. The first two are merely intended for self correcting. Third, exploit small but temporary deviations from equilibrium. This criterion is how foreign exchange traders earn their living. Finally, be able to predict the nature of government intervention in the foreign exchange market. This last one may be the most important.

One of the disadvantages of the forward and futures contract is the risk of losing the profit from favorable currency movement. That is why currency options were offered by Commercial Banks to give the consumers another choice of hedging. Currency option can be seen as the right, but not the obligation, to purchase or sell an underlying asset as a set price and date. By exercising currency option, holders have the right to either buy or sell in order to gain profit. 

Options pricing Method  

Bryan Robinson T TH 1 pm

Currency option, also named foreign exchange option, is a contract but not an obligation that grants the owner to buy or sell one currency at a pre-agreed exchange rate during a specified period of time. Some commercial banks offer currency option to their customers in order to make up losses from favorable movement.