Options on futures

Options on futures

We have noted that it is possible to use currency futures or currency options to hedge open currency positions or to speculate on price movements in particular currencies.A currency futures contract has a relative modest transaction cost in the form of brokerage commissions paid to specialist firms that operate on the futures exchange.In addition there are initial margin and maintenance margin costs.If an offsetting transaction is not made prior to expiration of the futures contract, the contract holder will have to make settlement.

In the case of a currency option, an initial premium is paid to the writer of the option contract, and commissions are paid in the trading of currency options on the exchange.However, there is no margin.Furthermore, the holder of the option may abandon it and use the spot market if that alternative is advantageous.

Options on futures contracts provide a third alternative for the hedger of speculator.If the hedger is short of the currency and desires protection against an upward movement in price of that currency, the hedger can purchase a call option on a given futures contract in that currency.