BAJAJ BROKING

Notification
No new Notification messages
Suraksha Diagnostic IPO is Open!
Apply for the Suraksha Diagnostic IPO through UPI in just minutes.
Open a Free Demat Account
Pay ZERO maintenance charges for the first year, get free stock picks daily, and more.
Q2 FY'24-25 Results of Top Companies
Reliance, TCS, HDFC Bank & more: Explore key financial highlights from India's top quarterly results.
Trade Now, Pay Later with up to 4x
Never miss a good trading opportunity due to low funds with our MTF feature.
Track Market Movers Instantly
Stay updated with real-time data. Get insights at your fingertips.

What is the Currency Option?

Listen to our Podcast: Grow your wealth and keep it secure.

0:00 / 0:00

Many tools in the stock market help traders make the best of their trading strategies, and currency option is one such tool. One of the main purposes of currency options is to help traders stay protected from the risks that are often associated with changing currency values. However, despite such changes, currency options also provide the chance for traders to benefit from these trades as well. Here, we will be discussing everything you need to know about currency options.

Understanding Currency Options in Detail  

A currency option can be defined as a derivative contract that provides traders with the right to sell or buy a particular amount of foreign currency, without the obligation to do so. This buying or selling of currencies is done at a fixed rate that is decided beforehand and is known as the strike price of the option. 

Trades under the currency option are carried out within a set time. Thanks to this time frame, traders can find ways to manage any potential risks associated with changes in currency values. If the market values move in the trader’s favour, they can stand to profit from it to a great extent.

There are two types of currency options- call options and put options. As a part of the call option, traders have the option to buy the underlying currency at the strike price agreed upon. Traders ideally use a call option when the currency value increases.

A put option, on the other hand, helps the trader to sell the underlying currency at the strike price and this currency option is usually used by traders when the currency value decreases. Both options, when utilised well, can help provide the traders with a safety net while working towards potential profits. 

 Additional Read: What is Trading Account: Definition, Types & Benefits

How the Currency Option Works  

There is one crucial and unskippable step that currency options cannot do without and that is the premium payment step. The payment of premium takes place between the option holder and the options seller. The option holder gains the right to either buy/sell the option, by paying the premium to the option seller.

Since option contracts come with an expiration date, the option holder ensures to stay on top of the movement of the current market rate of the currency pair. This is known as the spot price and it is a crucial element in determining how profitable either of the currency options will be. This is done by analyzing how it moves around the pre-defined strike price. Where the spot rate arrives at the expiration of the contract decides the option’s intrinsic value.

If and when the spot price crosses the strike price in call options, the option gains more intrinsic value and leaves the trader free to buy the currency they need at the strike price, which is now less than the current market price.

Conversely, when the spot rate falls below the strike price of a put option, the option holder can make a profit by selling it at the strike price, which is now higher than the market price. 

However, if the spot price scenarios are hypothetically exchanged between the two options, the option in question then ceases to exist as its intrinsic value disappears. However, the only loss that an option holder suffers in either of the two cases is the loss of the premium he paid to the option seller. 

Benefits of Currency Option   

There are several benefits to currency options. They can act as a hedge against potential losses when the currency moves in an unfavourable direction, against the trader. Essentially, the only loss a holder sustains, even if the price movement is against them is the amount they paid as the premium to the option seller. Conversely, if and when the currency moves in the trader’s direction, the profit potential is limitless. Options also offer the flexibility of the option holder having the right without needing to exercise the option. No obligation holds a trader down. There is a choice that exists for the trader. Options come with the benefit of being customizable to a trader’s goals and plans. As a result, traders have a personalised method to trade in currencies. Currency options also provide traders with the benefit of using a small amount of money to trade a bigger amount of currency through the method of leveraging. 

Features of Currency Option  

Several features make up currency options. Let us have a look at them. 

Features

Description

Over-the-counter contract

Most currency options are traded over the counter directly between two parties. No exchanges are involved in such a contract.

Customisable

Currency options have customisable terms that can be tailored to suit a trader’s needs

Exotic Options

The main aim of exotic options is to let traders bet on how much the currency can move apart from the diffraction it might take. This option works in favour of traders if currencies are moving extensively.

Versatile Expiry Dates

Since options can last either short-term or long-term, traders have a choice between how long they want to invest in the option as well. 

Additional Read: Call and Put Options: Meaning, Types & Examples

Types of Currency Option  

There are many types of currency options. Let us have a look at them here.

Traditional Currency Options

Traditional options enable an option holder to sell or buy a specific amount of foreign currency without the obligation to do so. This buying or selling is done at a predetermined rate which is known as the strike price and it needs to be carried out within a specified period.

  • Call Option
    The call option grants the option holder the right to buy the underlying currency at the strike price without the obligation to do so. Traders usually like to buy call options when they anticipate a rise in currency prices. 

  • Put Option
    A put option on the other hand provides the option holder the right to sell the underlying currency at the strike price without the obligation to do so. Traders prefer put options when they expect the value of the currency to drop.

Exotic Options

Exotic options have unique features that can be customized to meet the needs of the trader.  There are three types of exotic options:

  • Barrier Options
    The activation and deactivation of these options depend on the movement of the market and whether or not it hits a set level. This is where the knock-in or knock-out options get their name from.

  • Binary Options
    Any trader looking for a fixed payout should consider binary options. This however happens when the market price is above or below a certain level during expiration. 

  • Asian Options
    The payoff in an Asian option is governed by the average market price over a particular time frame and not the market price at expiration like in other options. As a result of this, Asian options are less volatile and cheaper than traditional options.

Over-The-Counter (OTC)

Trading of the OTC options is done directly between parties without the involvement of an exchange and results in easily customisable terms. However, OTC options also hold the risk of higher counterparty. 

Exchange-Traded Options

Exchange-traded options can be described as almost the opposite of OTC options as they are traded on organised exchanges and come with standardised terms. Exchange-traded options are also more transparent and have a counterparty risk.

Conclusion:

Currency options make for great investment choices to help traders gain access to flexible hedging and speculating tools when it comes to online currency trading. When traders understand how currency options work, they can truly tap into effective currency risk management and the profit that these options can produce through currency fluctuations.

Share this article: 

Frequently Asked Questions

What is a currency option meaning?

Answer Field

Currency options are derivative contracts that provide traders with the right to sell or buy a particular amount of foreign currency, without the obligation to do so. This buying or selling of currencies is done at a fixed rate that is decided beforehand and is known as the strike price of the option.

Why are currency options important?

Answer Field

One of the main purposes of currency options is to help traders stay protected from the risks that are often associated with changing currency values. However, despite such changes, currency options also provide the chance for traders to benefit from these trades as well

What are the key components of currency options?

Answer Field

There are four main components to currency options. These include the strike price, the expiration date, the contract size and the premium paid.

How does a currency option benefit investors?

Answer Field

Currency options help traders hedge against potential losses when the currency moves in an unfavourable direction, against the trader. Most options are customizable to fit a trader’s goals and plans. Along with this, traders can also use leverage to trade higher currencies at a fraction of their price. 

What are the main types of currency options?

Answer Field

There are four main types of currency options:  (a) traditional currency options, (b) exotic currency options, (c) Over the counter currency options and (d) exchange traded currency options.

No Result Found

Read More Blogs

Our Secure Trading Platforms

Level up your stock market experience: Download the Bajaj Broking App for effortless investing and trading

Bajaj Broking App Download

8 Lacs + Users

icon-with-text

4.8+ App Rating

icon-with-text

4 Languages

icon-with-text

₹5000+ Cr MTF Book

icon-with-text