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What is a Foreign Exchange Option?

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  • Written By: M. McGee
  • Edited By: Lauren Fritsky
  • Last Modified Date: 23 February 2020
  • Copyright Protected:
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A foreign exchange option is a financial agreement regarding the exchange of money from different countries. These agreements give the option to exchange money from one country to another country at a rate determined by the option. This form of trading is primarily a type called over-the-counter (OTC); this means it bypasses formal trading exchanges and happens directly between the concerned parties. The purchasing and trading of a foreign exchange option is a risky endeavor, as the foreign exchange market is one of the fastest moving and least stable global marketplaces.

The option part of a foreign exchange option is a specific type of financial instrument. Options give one party the ability to buy a specific item at a specific price. The person is not obligated to buy the item, but may if he chooses to. The purchase price of the item is set when the option is written and does not fluctuate with the market. Most options have an expiration date, after which they become worthless.

It is often even more risky to trade options than it is to trade other securities. Unlike most trading, where the buyer is able to see the exact price of a security and watch it rise and fall, an option has a set value. In this case, the people are not only betting on a price going up or down, but they are also banking that it will or won’t happen within the valid period of the option.

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The foreign exchange market converts currency for international commerce, but it is actually much more than that. This market allows people to buy and sell money as an actual item. As the conditions within a country change, the value of the country’s money goes up and down. Investors can purchase money when the price is low, such as during a period of civil unrest and sell it back after the country has an economic upswing.

Unlike many security exchanges, a foreign exchange option is typically done in relative privacy. While many securities are traded through formal exchanges, such as the New York Stock Exchange, most of the time, a foreign exchange option is not. These agreements are made directly between two parties, occasionally with the assistance of a third-party arbiter. In general, this means the amount of money traded is difficult to fully track and is less regulated than other markets.

Due to the fluid nature of money and the private nature of these contracts, the foreign exchange market is an ever-changing place. Since monetary value is based on a country’s stability, it incorporates all aspects of a society into its final price. While most securities are partially insulated from social or civil highs and lows, the foreign exchange market is not.

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