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What is Exchange Traded Currency Options / FX Options Explained | Trade Forex Options

What are Currency Options Trading

Option means a choice or an alternative.
 Option: It is a contract between two parties to buy or sell a given amount of asset at a pre- specified   price on or before a given date .
 The right to buy the asset is called call option and the right to sell the asset is called put option. 
 The pre-specified price is called as strike price and the date at which strike price is applicable is called expiration date. 
FX Options Explained | Trade Forex Options
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What is Exchange Traded Currency Options / FX Options Explained | Trade Forex Options

 Buying an option is also called as taking a long position in an option contract and selling is also referred to as taking a short position in an option contract. 

 The difference between the date of entering into the contract and the expiration date is called time to maturity. 
• The party which buys the rights but not obligation and pays premium for buying the right is called as option buyer and the party which sells the right and receives premium for assuming such obligation is called option seller/ writer.
• The price which option buyer pays to option seller to acquire the right is called as option price or option premium 
• The asset which is bought or sold is also called as an underlying or underlying asset. 

* Style of options :

 Based on when the buyer is allowed to exercise the option, options are classified into two types:  

 A. European options: European options can be exercised by the buyer of the option only on the expiration date. In India, all the currency options in OTC market are of European type. 

 B. American options: American options can be exercised by the buyer any time on or before the expiration date. Currently American options are not allowed in currencies in India.

 What is Exchange Traded Currency Options / FX Options Explained | Trade Forex Options
https://finosutra.blogspot.com/2020/05/introduction-to-currency-markets.html

* Moneyness of an option :

The buyer of call option would exercise his right to buy the underlying asset only if the spot price of underlying asset is higher than the strike price at the maturity of the contract. Similarly, the buyer of a put option would exercise his right to sell the underlying asset only if the spot price of underlying asset is lower than the strike price at the maturity of the contract . 

 If these costs are included, the decision of option buyer would take into account these costs also. Moneyness of an option indicates whether the contract would result in a positive cash flow, negative cash flow or zero cash flow for the option buyer at the time of exercising it. Based on these scenarios, moneyness of option can be classified in three types: In the money 

 1) (ITM) option: An option is said to be in the money, if on exercising it, the option buyer gets a positive cash flow. Thus a call option would be in the money, if underlying price is higher than the strike price and similarly a put option would be in the money if underlying price is lower than the strike price. Out of the money 

 2) (OTM) option: An option is said to be out of the money, if on exercising it, the option buyer gets a negative cash flow. Thus a call option would be out of the money, if underlying price is lower than the strike price and similarly a put option would be out of the money if underlying price is higher than the strike price. At the money 

 3) (ATM) option: An option is said to be at the money if spot price is equal to the strike price. Any movement in spot price of underlying from this stage would either make the option ITM or OTM. 

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What is Exchange Traded Currency Options / FX Options Explained | Trade Forex Options

* Option value :

The option value can be broken in two parts: 

 1) Intrinsic value: The intrinsic value of an option is the difference between spot price and the strike price. For a call option, the intrinsic value is Max (0, St-K), where K is strike price and St is the spot price of the asset. Therefore for an ATM option or an OTM option, the intrinsic value is zero as St is equal to K or lower than K. For a put option, the intrinsic value is Max (0, K-St). 

 2) Time value: The difference between option premium and intrinsic value is time value of option. The time value is directly proportional to the length of time to expiration date of the option. Longer the time to expiration, higher is time value. Therefore everything else remaining the same, call option on USDINR at a strike price of say 45 for two months   maturity would be priced higher than the call option at the same strike price for one month maturity. The time value reflects the probability that the option will gain in intrinsic value or profitable to exercise before its maturity. Therefore, higher time to expiration, higher the probability and higher the time value. 

What is Exchange Traded Currency Options / FX Options Explained | Trade Forex Options

* Option pricing methodology :


  There are two common methodologies for pricing options:

 • Black and Scholes: This methodology is more analytical, is faster to compute and is mainly used to price European options. 

 • Binomial pricing: This methodology is more computational, taken more computing power and is mainly used to price American options. 

 What is Exchange Traded Currency Options / FX Options Explained | Trade Forex Options


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The analogy I have used might not be 100% correct but it’s easy to understand things with a simpler analogy.
Feel free to connect me on LinkedIn : https://www.linkedin.com/in/akshay-s-kale-835463148
That’s it for this post. Do check out my other posts to gain more knowledge about finance.

 https://finosutra.blogspot.com/2020/05/what-is-exchange-traded-currency.html
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