Foreign Exchange: A Practical Guide to the FX Markets

CHAPTER 9

Foreign Exchange Options

“Foreign exchange: It’s not difficult; It’s just confusing.”

 

“Foreign exchange options: They’re not really difficult; They’re just really confusing!”

OPTION BASICS

An option is an instrument that affords one the opportunity, if one wishes, to trade (either to purchase or to sell) a certain amount of a certain asset at a certain predetermined price on or before some date in the future.¹ Those who learn options from a textbook (or even in a business area other than foreign exchange) are usually told that there are two types of options: call options and put options. A call option is a contract that gives its owner the right (but not the obligation) to buy (or to “call” to oneself) a certain amount of a certain underlying asset at a fixed price (known as the strike price or the exercise price) on or before some set date in the future (known as the expiration date or expiry). Similarly, a put option is a contract that gives its owner the right (but not the obligation) to sell (or to “put” to someone else, namely, the seller of the option) a certain amount of a certain underlying asset at a fixed price (the strike or exercise price) on or before expiration.

Brief but careful consideration of these definitions indicate that an option is very much like a forward contract, although a forward contract does involve a bilateral obligation on the part of the two counterparties, whereas the acquirer of an option has just that, the choice to buy (in the ...