Options Transaction

FOREX: Buying foreign Currency

To address the lack of flexibility in forward transactions, the foreign currency option was developed. An option is similar to a forward transaction. It gives its owner the right to buy or sell a specified amount of foreign currency at a specified price at any time up to a specified expiration date.

For a price, a market participant can buy the right, but not the obligation, to buy or sell a currency at a fixed price on or before an agreed upon future date. The agreed upon price is called the strike price.

Depending on which—the option rate or the current market rate—is more favorable, the owner may exercise the option or let the option lapse, choosing instead to buy/sell currency in the market. This type of transaction allows the owner more flexibility than a swap or futures contract.

Option to buy currency = Call option
Option to sell currency = Put option

Suppose a trader purchases a six-month call on one million euros at 0.88 U.S. dollars to a euro.

* During the six months the trader can either purchase the euros at the 0.88 rate, or purchase them at the market rate
* Option can be sold and resold many times before the expiration date
* Options serve as an insurance policy against the market moving in an unfavorable direction