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Option Types - Introduction
Whilst there appears to be an extraordinary and confusing array of currency options the majority of them fall into just a few categories. From these basic building blocks more complex and tailored structures are engineered to meet the hedging needs of end users.
Calls and PutsSince in every currency transaction one currency is bought and another is sold the same is true of options transactions. A Call option is the right to buy a currency and a Put option is the right to sell. If you buy a Call option on one currency you are by definition also buying a Put option on another. By definition each currency option is a Call and a Put on the respective currencies as you cannot do one without the other.
Knock-Out OptionsThese are like standard options except that they extinguish or cease to exist if the underlying market reaches a pre-determined level during the life of the option. The knockout component generally makes them cheaper than a standard Call or Put.
Knock-in OptionsThese options are the reverse of knockout options because they don't come into existence until the underlying market reaches a certain pre-determined level, at this time a Call or Put option comes into life and takes on all the usual characteristics.
Average Rate OptionsThe options have their strikes determined by an averaging process, for example at the end of every month. The profit or loss is determined by the difference between the calculated strike and the underlying market at expiry.
Basket OptionsA basket option has all the characteristics of a standard option, except that the strike price is based on the weighted value of the component currencies, calculated in the buyer's base currency. The buyer stipulates the maturity of the option, the foreign currency amounts which make up the basket, and the strike price which is expressed in units of the base currency.
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