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Published on Friday, August 24, 2018 by Chittorgarh.com Team | Modified on Monday, March 11, 2024
Currency Options have developed into a new asset class for investors. Currency options offer investors the opportunity to monitor exchange rates and use them for investment and hedging.
A currency option is a derivative contract that gives the buyer of the option the right, but not the obligation, to buy or sell the currency at a specific time and a predetermined price. The seller of the contract is obliged to fulfil the contract if the contract is exercised. The dynamics and mechanism of currency option trading are very similar to equity options. In every currency transaction, one currency is bought and another sold.
There are two types of currency options: Call and Put. A call option gives the right to buy, a put option gives the right to sell. Each transaction involves the purchase of one currency and the sale of another.
POSITION |
PROFIT POTENTIAL |
LOSS POTENTIAL |
---|---|---|
BUY a CALL option |
Unlimited |
Limited to the premium paid |
SELL a CALL option |
Limited to the premium received while selling the contract |
Unlimited |
BUY a PUT option |
Unlimited |
Limited to the premium paid |
SELL a PUT option |
Limited to the premium received while selling the contract |
Unlimited |
Currency options in India are European in nature, which means that the contracts can either be settled by taking an opposite position or exercised at expiry.
The currency options are traded on the NSE and the BSE. The market is regulated by the RBI and SEBI.
There are four types of currency pairs for currency options trading:
Lot Size: The lot size varies depending on the currency pair. For USD-INR, 1 lot size corresponds to 1000 USD. For EURINR, 1 lot size corresponds to 1000 EUR. For GBPINR it is 1000 GBP and for JPYINR it is 10000 JPY.
Underlying: The underlying is the exchange rate in Indian rupees for each currency pair.
Exercise Style: European, i.e. the contracts can either be closed out by taking an opposite position or exercised at maturity.
Tick Size: The strike price interval in these contracts is Rs 0.25.
Contract Cycle: There are three monthly contracts and 1 quarterly contract.
Margin: Premium for buying and SPAN + Exposure margin for selling
Expiration day: Two days before the last working day of the month.
Currency options can offer several advantages to traders and investors who want to speculate or manage currency risk. However, they also have some disadvantages. Here are some of the pros and cons of trading currency options:
Suppose, a company exports agricultural products to a European country, with revenue denominated in EUR. The company expects revenue in EUR after three months and hopes to make a profit.
A solid understanding of the factors that influence forex options pricing is important so that you can take advantage of price movements and maximize your profits from trades. 5 key factors influence the premium of call and put currency options: Foreign exchange rate, strike price, interest rate, time to expiration, and volatility. Read more here.
The break-even spot price is calculated by adding the strike price and the premium.
On the expiry date, all open long contracts in the money on a specific strike price of a series would be automatically exercised at the final settlement price at the close of trading and randomly assigned to open short positions on the same strike price and series.
Currency options are similar to equity options but are vastly different from different from commodity options.
Characteristics |
Equity Options |
Commodity Options |
Currency Options |
---|---|---|---|
Underlying |
Equity, Nifty, Bank Nifty |
Commodity Futures |
USD-INR, EUR-INR, GBP-INR and JPY-INR |
Lot size |
As decided by the exchange |
Lot size of Future contracts |
USD-INR- USD 1000 EUR-INR- EUR 1000 GBP-INR- GBP 1000 JPY-INR - JPY 10000 |
Exercise Style |
Stock Options- American Index Options- European |
European |
European |
Premium Pricing Model |
Black & Scholes |
Black 76 |
Black & Scholes |
Devolvement |
Expires worthless if not exercised |
Converted into Futures contract if not squared off |
Expires worthless if not exercised |
Moneyness |
ITM, OTM and ATM |
ITM, OTM, CTM and ATM |
ITM, OTM and ATM |
Expiry Date |
Last Thursday of the month |
3 days ahead of the expiry of Futures contract |
2 days ahead of the last working day of the month. |
Currency option |
Currency Swap |
An option is a right to buy/sell an asset at a specific time at a predetermined price. |
A swap is an agreement between two persons/parties to exchange cash flows from different financial instruments. |
The seller or writer of a call option would be obliged to sell the underlying asset at a predetermined price if the call option is exercised. |
Both parties are obliged to exchange cash flows. |
With options, securities are traded at their actual value. |
Swap contracts are concluded on the basis of cash flows. |
Options can be traded either on stock exchanges or over-the-counter (OTC). |
A swap is a type of over-the-counter (OTC) derivative that is individually structured and traded privately between two parties. |
A premium must be paid to purchase an option. |
No such payment is provided for in a swap. |
A currency option is a derivative contract that gives the buyer of the option the right, but not the obligation, to buy or sell the currency at a specific time and at a predetermined price. The seller of the contract is obliged to fulfil the contract if the contract is exercised. The dynamics and mechanism of currency option trading are very similar to equity options.
Currency options are used to minimize risk, speculate on currency fluctuations, and hedge international transactions. They offer the opportunity to benefit from favourable currency developments and to protect against adverse changes.
Some of the disadvantages of currency options contracts are:
Features of the currency option:
A foreign currency option (also known as a foreign exchange option or FX option) is a derivative financial instrument that gives the right, but not the obligation, to exchange money in one currency for another currency at a pre-agreed exchange rate on a specified date.
Currency derivatives are used to hedge investors against currency fluctuations in foreign currencies such as the euro, dollar, and yen. Investors often use these contracts for certain currencies when they are repeatedly affected by imports and exports.
The value of a currency changes due to supply and demand. An increase in demand for a particular currency increases the value of the currency, while an increase in supply decreases the value of the currency. The exchange rate is the value of one country's currency in relation to another.
Currency options can be used-
Every Friday of the week. If Friday is a holiday, the previous trading day is the expiry day/last trading day. All contracts expire at 12:30 pm on the expiry day.
The option contract would expire on the last working day (except Saturdays) of the contract month. The last working day is the same day as for interbank settlement in Mumbai. The rules for interbank settlement, including the rules for 'known holidays' and 'subsequently declared holidays', are as per the rules laid down by FEDAI.
A currency option gives the trader the right to buy/sell a certain currency at a certain price within a predetermined period of time, but not the obligation to exercise the option, even if the trade goes wrong. Currency options are used to hedge against unfavourable exchange rate fluctuations and speculate currency changes.
Options on currencies work in almost exactly the same way as options on other shares, indices, or commodities. The only difference is that currency options are quoted and traded in pairs. Among the rupee currency pairs, there are options on USDINR, GBPINR, EURINR, and JPYINR.
As with other equity options, currency options also have strike prices, terms, spot prices, and an option price. As with equity and index options, there are also call and put options for currency options, which include the right to buy or sell.
Trading currency options is similar to trading options on shares, indices, and commodities. As with regular options, there are also call and put options for currency options, which include the right to buy or sell. These options are European in nature and can be purchased via a stockbroker or an online trading platform.
By trading currency options, an investor can hedge against the risk of price increases and losses. Currency options are similar to regular options on stocks, indices or commodities and comprise two types of options - call and put options, which can be traded on exchanges or on any registered online trading platform. A put option protects the buyer of an option against a fall in the price of a currency, while a call option protects an option against a rise in the price of the currency. The advantage of such a strategy is that you can hedge against unfavourable developments for a premium
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