Currency Put Option

Currency put option definition

Currency put options are contracts that allow the buyer to sell a certain amount of a currency for an agreed-upon exchange rate on or before a specified expiration date, but does not obligate the buyer to do so. Currency put options, like other put options, are considered bearish, and indicate a belief on the part of the investor that the currency will decline in value. By purchasing a currency put option, an investor can ensure a guaranteed return on their currency investment even if the value of the currency falls sharply during the duration of the currency put option contract. If the currency’s value falls significantly, the investor can purchase the contract amount at the lower price and immediately sell it to the contract holder at the agreed-upon, higher cost, pocketing the difference as profit. If the currency’s value remains constant or increases, the buyer can allow the contract to expire without exercising the option. The seller is betting on this, and expects to make money on the currency put option premiums paid upfront by buyers.

Advantages of currency put options

Currency put options essentially put a floor under the price of the currency in question, ensuring that its value cannot fall below a certain specified level. This can provide companies and individuals with a method for hedging against potential losses. For example, a company that expects payment in a specific currency can purchase a foreign currency put option for the amount of the payment, thus ensuring that the amount paid will not fall below the amount guaranteed by the contract. Thus, the company can limit its risks while ensuring that it benefits from any profits if the currency increases in value.

FOREX market

Investors purchase currency put options on the FOREX market, the largest and most liquid such market in the world. Most transactions in the FOREX market are traded over the counter; this allows an investor to purchase a foreign currency put option without paying an exchange to serve as an intermediary, which can reduce costs for the transaction. FOREX currency options are generally subject to less regulation than exchange-mediated trades.
Tim Ord
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