Options on Forex

A buyer of an option acquires the right, but not the obligation, to buy or sell a specific amount of one currency for another at a predetermined price and date in the future. A “call” option is the right, without the obligation, to buy a currency. A “put” option is the right, without the obligation, to sell a currency. In every foreign exchange transaction, one currency is purchased and another currency is sold. Consequently, every currency option is both a call and a put. For example: an option to buy USD against YEN is both a USD call (ie buy US dollars) and a YEN put (ie sell Yen).

There are always two (2) parties to an option contract – the buyer and the seller. The buyer of the option enjoys the right to exercise the option and the right not to exercise the option (i.e. to let it lapse). The seller (also known as the ‘writer’ or ‘grantor’) of the option has the obligation to deal at the contracted rate if the buyer elects to exercise the option. Please note that the risk of the option buyer is limited to loss of the option premium paid, whilst an option seller has potentially unlimited risk.

The client specifies the rate at which they want to purchase or sell the currency (“strike price” or “exercise price”) and they determine the period of time for the option to exist (“maturity” or “expiration date”). The price of the option is known as the option premium. The buyer pays the premium to the seller as compensation for the risk involved in writing the option. The option premium is paid on the spot value from the date on which the option is contracted.

In other words, to facilitate the option deal, the buyer of the option (usually the client) is required to pay an amount (“premium”) to the seller. Paying the premium allows the client to keep the option until its maturity date, or to sell it at any given point of time prior to its maturity. The seller of the option determines the price of the premium at which it is willing to grant the option, based on current rates, nominated delivery and expiry dates, the nominated strike rate and option style.

The premium for an option at a particular time represents a consensus of the option's current value which is comprised of intrinsic value and time value. Intrinsic value is simply the difference between the spot price and the strike price. A put option will have intrinsic value only when the spot price is below the strike price. A call option will have intrinsic value only when the spot price is above the strike price. Time value is more complex. When the price of a call or put option is greater than its intrinsic value, it is because it has time value. Time value is determined by the principal considering the following factors:
• the spot or underlying price;
• the expected volatility of the underlying currency;
• the exercise price;
• time to expiration; Time value falls toward zero as the maturity date or expiration date approaches.
• the difference in the "risk-free" rate of interest that can be earned by the two currencies.

Options traded are European options and thus, may only be exercised at the strike price at the expiration date which results in a cash adjustment between the strike price and the current market price as determined by the Principal. This is in contrast to American Options that are capable of exercise at the strike price at any time before the expiration date.

Clients can also sell options, however this is NOT recommended unless you are a professional trader. Since the seller of the option has the obligation to deal at the contracted rate if the buyer elects to exercise the option, there is unlimited risk to the seller of the option.

Please note that all option contracts must have a minimum expiry date being seven (7) days from execution date to a maximum period (expiry date) of six (6) months.