Currency Trading and Options

Currency trading is essential for anyone who needs a foreign currency for a foreign trip or for payment of university fees abroad, importers and exporters, financial institutions, corporations and others. Currency trading is used as a hedging tool by all the stakeholders.

Forex or the Foreign Exchange is the largest financial market in the world. Exchange rates have a huge impact on the exporters as well as importers. A depreciation in the currency benefits the exporter whereas an appreciation in the currency benefits the importer. The exporter gets paid more dollars when there is rupee depreciation against dollar whereas an importer will get affected as he has to pay more dollars for his import. This in turn will increase the exports whereas decrease the imports.

Options:

A currency option agreement grants the buyer the right to buy or sell a specific currency at a specified exchange rate on or before a specified date but has no obligation to fulfil the contract. The buyer has to pay a premium to buy the contract. Investors hedge against currency risk by purchasing a currency put or call.

The buyer can exit the contract if the currency price is not in his favor. So his losses are limited to the premium whereas profits are unlimited. The option value is of 2 parts: Intrinsic value and Time value.

Intrinsic value:

A call option has intrinsic value when the strike price is below spot price and a put option has intrinsic value if the strike price is above spot price.

In the money: It is said to be in the money when in case of call option if the spot price is higher than the strike price and for a put option, if the spot price is below strike price.

Out of the money: It is said to be out of the money in case of call option if the spot rate is less than the strike price and in case of put option, it is out of the money when the spot price is more than the strike price.

At the money: Here, the strike price and spot price remain the same.

Currency options are of two types: American and European terms: An European option can be exercised on the expiration date only whereas an American option can be exercised at anytime.

Currency trading via options offers leverage. The amount of premium is relatively small when compared to the cost of buying the same amount of stock. Options can be used to hedge against various risks of trader.