In any kind of securities trading, an option is a right but not obligation to buy a said security or currency in the stock exchange or a Foreign exchange market (also known as Forex). So, the trade here essentially is the trade of rights.
In the international foreign exchange market options are used by a variety of organizations and institutions to serve a variety of purposes such as liquidity, hedging, and for international trades. In some cases, such options are also prominently used in arbitration and Forex trading transactions. Overall, there are several merits and also some demerits.
About Trading in Currency Options
Investing in option trading is quite complex, and there are several different aspects that have to be considered by currency options traders. The mechanics of this form of trading involves speculation of prices for certain currencies.
On a specified date, say as of today, $1 is equal to ₹62 (Indian Rupee), however, the rate is bound to change in future, in a positive or even negative manner. The future anticipated rate is an important aspect of all for people who deal in the International currency market or the Forex market.
The currency option is a contract between two people, one who holds an Indian Rupee, and secondly the one who holds a United States Dollar, and wants the Indian Rupee or some future transaction or purpose. These two people can sign a contract.
The current owner of the Indian Rupees in exchange of a small commission, grants a specific right to the potential buyer which is known as option. Option is basically a contract, according to which the buyer has a right but not an obligation to purchase a specified currency at a pre-specified rate and date. In some cases, the rate may not even be specified.
While trading, this right can be traded by the holder as against money or other rights or a combination of both. Such options come in real handy to traders in cases where the rate of the currency is rising. This increases the profit margin of the trade.
There are three very good merits from the buyer's point of view:
- The option is not an obligation and can be rejected or not brought.
- The option is a right that can be further traded for a higher price.
- The second advantage is that, in many cases, the price for a future date is greater than the option price. Now, it so happens that the market price in future can become much higher than the decided price. This is where the person dealing in currency options can capitalize upon.
- Thirdly, if the buyer needs the currency, then he can just use the option, instead of trading it. In such a situation, he will end up saving a lot of money, as in the future date the cost of the currency in question can rise substantially.
Initially, the work involved was conformed to trading companies who dealt in international trade, import and export. Such an option and its trade was used to subsidize expensive imports or increase the monetary value of exports.
Today, however, Forex investors and traders often take up trading in currency options to profit from the increase in the value of a nation's exchange rate. Separate strategy is framed with the help of deep study of national economies.
However, please note that such investment is very risky and also complicated, and it is evidently important that having a thorough understanding is necessary before starting any kind of currency option trading on a regular basis. Also, planning trading strategies that work, will work wonders.