Currency Options Essay

703 words - 3 pages

Topic: Currency Options

Currency option is a contract or an agreement which gives the right to buy or sell currency at a pre-specified exchange rate on a future date. Currency options are derivatives contracts in which 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 and gives the buyer the right but not the obligation to buy or sell the underlying foreign currency at a specified price on an agreed upon date in the future. There is an expiration date on the contract so there is a time factor. In addition, the option comes at a cost. The fee that the buyer pays for the option is called the premium. The price that is specified for either buying or selling at the future date is known as the strike price.

There are two types of contract when it comes to price movements, the call and put option. A call option is when you expect the price of the ...view middle of the document...

Currency option trading is a strategy that many traders use to make profits and hedge their risks on the forex market. You can use it purely to speculate or you can use it to limit your losses in this risky market. This option suits many businesses that want to protect themselves from unfavorable rate changes while retaining the flexibility to benefit from advantageous ones.
There are many benefits to trading currency options. Currency options are loved by most of the traders. In currency options trading they seem to have great amount of gains and very less risks. First of all, it is a method of speculating on the forex market while limiting your losses. The price of a currency pair does not meet or exceed the strike price, you simply let the contract expire and you are limited to the loss of your premium. In other words, you're protected from any adverse movements in the exchange rate. Also, no matter how much your currency tanks, you will only lose your premium and nothing more, except maybe your pride. The second benefit of currency options is that your business can benefit if the exchange rate moves in your favour. It usually relies on the movement of the long term market. So this will provide you with the opportunity in which you can apply some strategic trading. Long term market will also be much more predictable and due to this you will have chances of greater profit. In addition, currency options can be traded 24 hours a day. There are disadvantages associated with currency options, too. The main disadvantage if you want to trade currency options is that there is a time limit. If you don't hit your strike price before the expiration date, you are out your premium. If it hits your strike price the day after the expiry date, it's too late. Besides, currency options change in 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. Last but not least, currency options are only available to companies with large foreign exchange exposures. Currency options have lots of benefits. It is also true that there are certain disadvantages of it but its advantages tend to overshadow its disadvantages.

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