Understanding Options & difference between Forwards & Options

In this article, we are going to understand currency hedging product known as Currency Options.Exporters / Importers get into financial contract hedging to protect their exchange losses or adverse movement of currency which may arise due to commercial contract payment terms. Hedging helps us to give a visibility of exchange rates on future dates thus, cash flows can be managed well.Currency Options or FX Options are commonly used terms in banking & finance. It is a derivative product which gives the authority but not the obligation to deliver the currency at the agreed exchange rate on a specified date i.e., the Maturity date.This article will help us understand the vanilla option contract i.e, Call option & Put Option.Call Option:Call Option gives the right but not an obligation to buy the foreign exchange at an agreed exchange rate on the maturity date.Put Option:Put Options gives the right but not an obligation to see the foreign exchange at an agreed exchange rate on the maturity date.Factors Influencing Pricing of Option Contract:1.Strike PriceThe Strike price is basically the exchange rate at which the derivative can be exercised on the maturity date. Strike price forms an integral part of pricing an Option. Strike Price is nothing but, agreed exchange rate on maturity. This strike price is compared relative to the present value of exchange between the currency pair of the underlying options contract to determine whether it's “In the money” or “Out of Money”.This is one of the major factors which could influence your options contract.Spot Rate:Spot is the interbank rate available at the time of entering into the options contract.Volatility:This is basically the historical and the anticipated currency movement between the currency pair being hedged for the period of hedge.Premiums:Premium is the cost that incurred to avail options contract from your Authorized Dealer. Premium becomes an expense in your balance sheet immediately upon availing the options contract.Bank Margins:Bank Margins are generally inbuilt in premiums when it's offered to you by the authorized dealer.Difference between Forward Contract & Options:1.No direct cost is involved in availing a forward contract however, there is a premium cost in options contract.2.Forward contract is an obligation however Options is a right.In case you have any clarification relating to hedging,please write to us advisor@savedesk.co
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Understanding Options & difference between Forwards & Options

Piuesh Daga
Blog
12th Oct, 2017
Understanding Options & difference between Forwards & Options

In this article, we are going to understand currency hedging product known as Currency Options.

Exporters / Importers get into financial contract hedging to protect their exchange losses or adverse movement of currency which may arise due to commercial contract payment terms. Hedging helps us to give a visibility of exchange rates on future dates thus, cash flows can be managed well.

Currency Options or FX Options are commonly used terms in banking & finance. It is a derivative product which gives the authority but not the obligation to deliver the currency at the agreed exchange rate on a specified date i.e., the Maturity date.

This article will help us understand the vanilla option contract i.e, Call option & Put Option.

Call Option:

Call Option gives the right but not an obligation to buy the foreign exchange at an agreed exchange rate on the maturity date.

Put Option:

Put Options gives the right but not an obligation to see the foreign exchange at an agreed exchange rate on the maturity date.

Factors Influencing Pricing of Option Contract:

1.Strike Price

The Strike price is basically the exchange rate at which the derivative can be exercised on the maturity date. Strike price forms an integral part of pricing an Option. Strike Price is nothing but, agreed exchange rate on maturity. This strike price is compared relative to the present value of exchange between the currency pair of the underlying options contract to determine whether it's “In the money” or “Out of Money”.This is one of the major factors which could influence your options contract.

Spot Rate:

Spot is the interbank rate available at the time of entering into the options contract.

Volatility:

This is basically the historical and the anticipated currency movement between the currency pair being hedged for the period of hedge.

Premiums:

Premium is the cost that incurred to avail options contract from your Authorized Dealer. Premium becomes an expense in your balance sheet immediately upon availing the options contract.

Bank Margins:

Bank Margins are generally inbuilt in premiums when it's offered to you by the authorized dealer.

Difference between Forward Contract & Options:

1.No direct cost is involved in availing a forward contract however, there is a premium cost in options contract.

2.Forward contract is an obligation however Options is a right.

In case you have any clarification relating to hedging,please write to us advisor@savedesk.co

Piuesh
Blog Author

Piuesh is the cofounder of White Matter Advisory and is responsible for the overall delivery and execution at WMA. He profoundly believes in significance of financial literacy in emerging markets. He is the youngest amongst the co-founders with an overall experience of 7+ years in the banking industry.

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