The Derivatives - Currency Options

A Currency option gives the buyer the right but not the obligation to buy or sell a given quantity of currency in the future at the specified price (exercise/strike) agreed upon today.

The writer of a option promises to buy or sell the currency if required to do so by the call option holder.

Currency options are either exchange traded (Philadelphia stock exchange) or over the counter (at bank). Options can either be European (exercised only at maturity) or American (exercised any point till the maturity)

Value of an option (option premium) is given by its

a)      Intrinsic value is the financial gain if the option was to be exercised immediately (indicated by its Moneyness i.e. in- the- money and if the option out of the money then intrinsic value is 0.) and the

b)      Time value which exists because the option could move into the money between the purchase date and the exercise dare

                               

Thus premium of an option is always somewhat greater than its intrinsic value.

Options in Stock Exchange

If one at the Philadelphia SE the $/GBP quotations would be given. Note that for higher exchange rate, the premium for call option is lower since the higher exchange rate is less favourable for the buyer of option (i.e. more $ needed to buy the same amount of GBP). However, For the higher exchange rate, the premium for put option is higher since the higher exchange rate is more favourable for the seller of option (i.e. receive more $ by selling the same amount of GBP).

               

                Also those options with longer expiry date (e.g. Sept options against Aug options) will cost more than an option with earlier expiry at the same exercise price. This is because longer period options have a greater likelyhood to be in the money at the excercise date.