Option is a right but not liability to acquire or sell foreign currency in the future at an exchange rate fixed in advance.
Advantages of options:
- This service is favourable for the option purchaser as it entitles to the unlimited gain and the maximum possible loss would be the premium-size amount;
- Hedging against possible changes in the rate and related loss;
- Transaction is enforceable only at the purchaser's request;
- No forward limit is required for the option.
During the time of option the purchaser pays a commission fee (premium) to the option seller and acquires the right to purchase or sell currency. Option seller has to execute the transaction if it is required so by the purchaser. During the time of option the option purchaser himself chooses the price for the execution of the option based on which the option premium is determined.
Option types:
- Call option - right to purchase currency. Call option is enforceable if market rate is higher than the option rate. In that case the holder of call option shall be able to purchase currency at a lower than market price. In case the rate is not acceptable and the holder of call option can buy cheaper on the market the option shall not be used;
- Put option - right to sell currency. Put option is enforceable if the market rate is lower than the option rate. In that case the holder of put option shall be able to sell currency at a higher than market price. In case the rate is unacceptable and the holder of put option can sell at a higher price in the market the option shall not be used.