Trading Currency Options: A Brief Overview

Retail forex traders primarily have 2 types of options at their disposal.

1. Call or Put Option – A call option grants the buyer the right to purchase a currency pair at a specified exchange rate in the future. Conversely, a put option gives the buyer the right to sell a currency pair at a certain exchange rate in the future.
2. Single Payment Options Currency Trading (SPOT) – These options are simpler to set up and execute. However, their premium costs are higher compared to traditional options.

Pricing of Foreign Exchange (FX) Options

Also known as Forex options or currency options, FX options pricing attempts to quantify the measure of risk involved. The price of a currency option can be divided into two parts – intrinsic value and time value. The calculation of time value is complex as it is influenced by various factors. The volatility of the currency and the remaining time until expiration are the primary parameters used in the calculation. The intrinsic value is the profit that can be realized by exercising the option, assuming that the FX spot rate will remain the same as the current rate on the expiration date.

Nature of FX options: American or European?

The style of an FX option determines when the currency option can be exercised.

1. European Style – The price at the expiration date is the only factor that matters.
2. American Style – This option can be exercised at any time on or before its expiry. It offers more flexibility but comes at a higher cost.

The information provided above will be beneficial for those preparing for UPSC 2021 .

Related Links