7.3　Currency options

Currency options give the holder the right to exercise the option until its expiration.Call options give the holder the right, but not the obligation, to purchase the currency at a price set in the contract called the strike price.Putting options give the holder the right, but not the obligation, to sell the currency at a price set in the contract.American style options can be exercised at any time until expiration of the option.By contrast European style options can be exercised only at the maturity date.

There are two parties to an option contract: the option seller or writer and the option buyer who can be a hedger or speculator.The buyer essentially purchases a commitment that the option writer will stand ready to sell or purchase a specified amount of the underlying currency on demand.The option buyer’s cost for this right, the premium, is paid to the option writer.Currency options are purchased and traded either on an organized exchange, such as the Philadelphia Exchange, or in the over-the-counter market.Exchange-traded options are standardized contracts, in multiples of standard amount, with predetermined exercise (strike)prices and standard maturities.

An important factor limiting the use of options as compared with futures is that they can be expensive to use.In other words, a substantial premium can be paid, and then the option may not be exercised.For this reason it is necessary to compare the option solution with alternative type hedges.