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Online Currency Trading, Differences between Futures Contracts and Currency Options in Forex Trading

Online Currency Trading, Differences Between Futures Contracts and Currency Options In Forex Trading: A “futures exchange contract” is an exchange trading transaction where a specific future date or period is set as the reservation’s execution date or period. 

The exchange rate for settlement of foreign currency with the bank is agreed in advance. There is a phrase “reservation”, but in foreign exchange transactions with banks, it is stipulated as “sales transaction” in the “foreign exchange reservation transaction agreement”. 

The trading price (futures exchange rate) is decided in advance between the bank and the customer and executed. 

Once you make a reservation, you cannot cancel it in principle, and you will be obliged to deliver it (complete the reservation) on the due date. 

For this reason, it is treated as a credit transaction for banks. On the other hand, “currency options trading” refers to trading the right to buy or sell foreign currency at a specific price (exercise price) in the future at a particular time (exercise period).

Currency Options Trading with Online Currency Trading

There are four types of currency options trading as follows.

Online Currency Trading, Differences between Futures Contracts and Currency Options in Forex Trading
  • “Buy” of call options (right to buy foreign currency)
  • “Sell” of call options (right to buy foreign currency)
  • “Buying” put options (right to sell foreign currency)
  • “Sell” of put options (right to sell foreign currency)

Whether the buyer of options trading “exercises” (or “executes”) or reserves the right to purchase (the right to buy foreign currency or the right to sell foreign currency) while watching the movement of the exchange rate after the due date you can select. 

That is, there is a “choice right”. On the other hand, in the case of futures exchange contracts, even if the exchange rate on the day of reservation execution becomes a level that is more favourable to the company than the already concluded reservation rate, it cannot be cancelled for this reason, and it is executed on the due date. 

On the other hand, if you buy a currency option, you can waive that right if the exchange rate on the due date (option exercise date) becomes more favourable than the option exercise price. 

Therefore, the buyer of a currency option pays a premium (“option premium”, “option fee”, “option price”, etc.) to the seller in advance at the time of contract as consideration for securing the right. 

In other words, currency options buyers have the option of “exercising” or “waiving” their rights, which is crucially different from futures contracts.

On the other hand, sellers of currency options should receive once the buyer exercises their rights. In return for that obligation, you will receive a premium in advance from the requesting buyer. 

In that case, the loss is theoretically infinite, so you need to be careful when joining as an option seller. When using currency options for currency risk hedging, it is safer to participate as a buyer.

Transaction costs and profitability

For futures exchange contracts, the exchange’s cost and profitability will be fixed at the time the contract is concluded. 

Online Currency Trading, Differences between Futures Contracts and Currency Options in Forex Trading

For example, in the case of a US dollar-denominated futures exchange contract, there is no need for other direct costs (commissions, etc.) because it is determined by the interest rate difference between the US dollar and INR bilateral currencies and the cost of the bank margin, etc. related to the reservation. 

In the case of currency options trading, the option buyer must pay the seller a premium in exchange for the rights. The premium character is like a kind of insurance premium. 

The premium level is determined by factors such as the current market price, exercise price, time to date, interest rates, and volatility.

Besides, the option’s buyer will waive the right to purchase if the exchange rate becomes disadvantageous contrary to the initial expectation. 

Still, the buyer’s loss (profit of the seller) in the case of waiver is. The premium paid is the limit. On the other hand, the buyer’s profit and the loss of the seller when exercising the right are (theoretically) infinite.

Use of both in practice

From a practical point of view, futures exchange contracts’ essential purpose of fu determines the amount of foreign currency received for export transactions or INR to consider foreign currency paid for import transactions. 

For currency options, instead of the option buyer paying the premium to the seller, the exchange condition is a mixture of forecasts of fluctuations in the exchange rate’s future and the speculation of both the buyer and seller of the option rather than the usual futures exchange contract. 

Online Currency Trading, Differences between Futures Contracts and Currency Options in Forex Trading

In this way, both foreign exchange futures contracts and currency options effectively reduce the risk of exchange fluctuations on foreign currency receivables and debts. 

The periods and mechanisms that can be used for each can be handled in various ways. We recommend that you consult with a financial institution.

Conclusion

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