Option
An option confers on the buyer the eligibility to buy or sell a sum of foreign currency at a pre determined rate on a future date, without investing him with an obligation to do so. On the due date, buyer of the option may elect to buy or sell as per his entitlement or he may choose to let it go unused. Either of the decision is binding on the seller, who has no such discretion.
Essentially this type of contract serve the similar purpose as a forward exchange contract., viz, to firm up the future payment/receipt in a foreign currency with regard to exchange rate in terms of the local currency. The difference between the foreword contract and option is that under foreword contract , the customer is expected to deliver/receive the foreign exchange on the due date at the foreword rate irrespective of the spot rate prevailing. Under an option contract , on the due date , the customer can make a reassessment of the situation and seek either execution of the contract or its non- execution as may be advantageous to him.
Features of option contracts:
Parties: There are two parties of this type of contract – the option buyer and the option seller. Option buyer is the holder of the right under the contract to buy or sell one specific currency against another specific currency. Normally it would be the exporter or importer or the corporate treasurer who would be buying the option from the seller.
Option seller also known as the writer, is the one who makes the right available to the buyer. He should deliver or accept delivery of the currency concerned when the right is exercised by the option buyer. Normally the writer of the option will be the bank which provides this instrument to its customer. The seller of the option is always at a disadvantageous position because the buyer will exercise his right only if the prevailing exchange rate is favorable to him. This also means that the rate is unfavorable to the seller.
