Forex
Options Market Overview
The forex options market started as an over-the-counter (OTC)
financial vehicle for large banks, financial institutions and large
international corporations to hedge against foreign currency exposure. Like the
forex spot market, the forex options market is considered an
"interbank" market. However, with the plethora of real-time financial
data and forex option trading software available to most investors through the
internet, today's forex option market now includes an increasingly large number
of individuals and corporations who are speculating and/or hedging foreign
currency exposure via telephone or online forex trading platforms.
Forex option trading has emerged as an alternative investment
vehicle for many traders and investors. As an investment tool, forex option
trading provides both large and small investors with greater flexibility when
determining the appropriate forex trading and hedging strategies to implement.
Most forex options trading is conducted via telephone as there
are only a few forex brokers offering online forex option trading platforms.
Forex Option Defined - A forex option is a financial currency
contract giving the forex option buyer the right, but not the obligation, to
purchase or sell a specific forex spot contract (the underlying) at a specific
price (the strike price) on or before a specific date (the expiration date).
The amount the forex option buyer pays to the forex option seller for the forex
option contract rights is called the forex option "premium."
The Forex Option Buyer - The buyer, or holder, of a foreign
currency option has the choice to either sell the foreign currency option
contract prior to expiration, or he or she can choose to hold the foreign
currency options contract until expiration and exercise his or her right to
take a position in the underlying spot foreign currency. The act of exercising
the foreign currency option and taking the subsequent underlying position in
the foreign currency spot market is known as "assignment" or being
"assigned" a spot position.
The only initial financial obligation of the foreign currency
option buyer is to pay the premium to the seller up front when the foreign
currency option is initially purchased. Once the premium is paid, the foreign
currency option holder has no other financial obligation (no margin is
required) until the foreign currency option is either offset or expires.
On the expiration date, the call buyer can exercise his or her
right to buy the underlying foreign currency spot position at the foreign
currency option's strike price, and a put holder can exercise his or her right
to sell the underlying foreign currency spot position at the foreign currency
option's strike price. Most foreign currency options are not exercised by the
buyer, but instead are offset in the market before expiration.
Foreign currency options expires worthless if, at the time the
foreign currency option expires, the strike price is
"out-of-the-money." In simplest terms, a foreign currency option is
"out-of-the-money" if the underlying foreign currency spot price is
lower than a foreign currency call option's strike price, or the underlying
foreign currency spot price is higher than a put option's strike price. Once a
foreign currency option has expired worthless, the foreign currency option contract
itself expires and neither the buyer nor the seller have any further obligation
to the other party.
The Forex Option Seller - The foreign currency option seller may
also be called the "writer" or "grantor" of a foreign
currency option contract. The seller of a foreign currency option is
contractually obligated to take the opposite underlying foreign currency spot
position if the buyer exercises his right. In return for the premium paid by
the buyer, the seller assumes the risk of taking a possible adverse position at
a later point in time in the foreign currency spot market.
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