Description:-
Traditional options allow the buyer the right (but not the obligation) to purchase something from the option seller at a set price and time. Since forex options are traded over-the-counter (OTC), traders can choose the price and date on which the option is to be valid and then receive a quote stating the premium they must pay to obtain the option.
Type of option contracts,
A Call Option is an option to buy the contract.
A Put Option is an option to sell the contract.
American Option in which the owner is allowed to enter the swap on any day that falls within a range of two dates.
European Option in which the owner is allowed to enter the swap only on the maturity date.
Bermudan Option in which the owner is allowed to enter the swap only certain dates that fall within a range of the start (roll) date and end date.
Why are they traded?
An investor believes that the USD/EUR rate is going to increase from 0.70 to 0.80 (meaning that it will become more expensive for a European investor to buy U.S dollars). In this case, the investor would want to buy a call option on USD/EUR so that he or she could stand to gain from an increase in the exchange rate (or the USD rise).
Example:-
A GBPUSD contract could give the owner the right to sell £1,000,000 and buy $2,000,000 on December 31. In this case the pre-agreed exchange rate, or strike price, is 2.0000 USD per GBP (or GBP/USD 2.00 as it is typically quoted) and the notional amounts (notionals) are £1,000,000 and $2,000,000.
This type of contract is both a call on dollars and a put on sterling, and is typically called a GBPUSD put, as it is a put on the exchange rate; although it could equally be called a USDGBP call.
If the rate is lower than 2.0000 on December 31 (say at 1.9000), meaning that the dollar is stronger and the pound is weaker, then the option is exercised, allowing the owner to sell GBP at 2.0000 and immediately buy it back in the spot market at 1.9000, making a profit of (2.0000 GBPUSD – 1.9000 GBPUSD)*1,000,000 GBP = 100,000 USD in the process. If they immediately convert the profit into GBP this amounts to 100,000/1.9000 = 52,631.58 GBP.
Life cycle events: –
Premium and pay off’s.
OTCWIRE 