Forex Futures and Options
The foreign exchange (Forex) market provides opportunities for investors to make profits from currency exchange rate fluctuations. It also helps businesses minimize risk from exposure to foreign currencies. Investment instruments in the Forex market include futures and options. The value of these instruments depend on the value of the underlying currencies.
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Forex Futures
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When you buy Forex futures, you enter into an agreement to buy a standard amount of currency at a fixed price at a specified time. If the price of the currency rises above the fixed price at the maturity date, you make a profit, because you are buying the currency below the market price. If you expect the price of the currency to drop, you sell Forex futures.
Forex Options
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While Forex futures obligate you to make the transaction at the maturity date, Forex options provide you with the right, but not the obligation, to buy or sell an amount of currency. When you buy a Forex option, you obtain the right to buy or sell a currency at a certain exchange rage. However, you do not have to buy or sell the currency if it will not be profitable. Two types of Forex options exist: call options and put options.
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Forex Call Options
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The buyer of a Forex call option obtains the right to purchase a certain amount of currency at a fixed price. It becomes profitable for the buyer to use or exercise the Forex call option if the price of the currency increases beyond the exercise price of the option. The seller of the call option would have to sell the currency at a loss. If the price of the currency is below the exercise price, the buyer doesn't use it, and the seller makes a profit from the money the buyer paid to purchase the option.
Forex Put Options
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The buyer of a Forex put option obtains the right to sell a specified amount of currency at a fixed price. If the price of the currency drops below the exercise price of the put option, the buyer would use the option to sell the currency above the market price, making a profit. If the price of the currency rises above the exercise price, the buyer would let the option expire, and the seller would make a profit.
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