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Currency Options Basics- Explained With Examples

Published on Friday, August 24, 2018 by Chittorgarh.com Team | Modified on Thursday, November 14, 2019

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CurrencyOptions have emerged as a new asset class for investors. Currency options provide an opportunity for investors to take a view on Exchange Rate and use it for investment and hedging.

What is a Currency Option (Currency Options Meaning)

A Currency option is a derivative contract which gives the buyer of the option the right, but not the obligation, to buy or sell the currency at a stated date and at a predetermined price. The seller of the contract has the obligation to honour the contract when the contract is exercised. The dynamics and mechanism of currency options trading are very similar to equity options.

There are two types of currency options: Call and Put. A call option gives the right to buy and a put option gives the right to sell. In every transaction, one currency is bought and another sold.

Profit/Loss Potential For Positions in Currency Options

POSITION

PROFIT POTENTIAL

LOSS POTENTIAL

BUY a CALL option

Unlimited

Limited to the premium paid

SELL a CALL option

Limited to the premium received while selling the contract

Unlimited

BUY a PUT option

Unlimited

Limited to the premium paid

SELL a PUT option

Limited to the premium received while selling the contract

Unlimited

Currency Options in India are European in nature which means the contracts can either be squared off by taking an opposite position or can be exercised on expiry.

The currency options are traded in NSE and BSE. The market is regulated by the RBI and SEBI.

Currency Options Contract Specifications

Four types of currency pairs are available for trading in currency options-

  1. USD-INR
  2. EUR-INR
  3. GBP-INR
  4. JPY-INR

Lot Size: The lot size varies depending on the currency pair. For USD-INR, 1 lot size denotes USD 1000. For EURINR, 1 lot size is EUR 1000. For GBPINR, it is GBP 1000 and for JPYINR, it is JPY 10000.

Underlying: The underlying would be the exchange rate in Indian rupees for each currency pair.

Exercise Style: European in nature which means the contracts can either be squared off by taking an opposite position or can be exercised on expiry.

Tick Size: The strike price interval in these contracts is Rs 0.25.

Contract Cycle: There are three monthly contracts and 1 quarterly contract.

Margin: Premium for buying and SPAN + Exposure margin for selling

Expiration day: Two days prior to the last working day of the month.

Difference Between Equity, Commodity & Currency Options

Currency options are similar in nature to equity options but are vastly different from different from commodity options.

Equity Vs Commodity Vs Currency Options

Characteristics

Equity Options

Commodity Options

Currency Options

Underlying

Equity, Nifty, Bank Nifty

Commodity Futures

USD-INR, EUR-INR, GBP-INR and JPY-INR

Lot size

As decided by the exchange

Lot size of Future contracts

USD-INR- USD 1000 EUR-INR- EUR 1000

GBP-INR- GBP 1000

JPY-INR - JPY 10000

Exercise Style

Stock Options- American

Index Options- European

European

European

Premium Pricing Model

Black & Scholes

Black 76

Black & Scholes

Devolvement

Expires worthless if not exercised

Converted into Futures contract if not squared off

Expires worthless if not exercised

Moneyness

ITM, OTM and ATM

ITM, OTM, CTM and ATM

ITM, OTM and ATM

Expiry Date

Last Thursday of month

3 days ahead of expiry of Futures contract

2 days ahead of the last working day of the month.

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