- Profit or loss from FX (currency) transactions is affected by fluctuations in foreign exchange rates
- Maximum loss for the option buyer is limited to the paid premium
- Risk associated with sold options is much higher that with purchased options (loss of the option seller may significantly exceed the received premium)
- Option seller commits to purchase or sell underlying instruments
- In case an option is exercised, the option seller is in a situation, where the current market price of underlying assets sold by the seller may be significantly higher than the strike price or, conversely, the current market price of underlying assets purchased by the seller may be considerably lower than the strike price (to which the seller committed)
- Barrier option buyer assumes a risk that the option purchased by the buyer might expire prior to expiration date (knock-out option) or may not be activated at all (knock-in option)
- Profit or loss from FX (currency) transactions is affected by fluctuations in foreign exchange rates
- Maximum loss for the option buyer is limited to the paid premium
- Risk associated with sold options is much higher that with purchased options (loss of the option seller may significantly exceed the received premium)
- Option seller commits to purchase or sell underlying instruments
- In case an option is exercised, the option seller is in a situation, where the current market price of underlying assets sold by the seller may be significantly higher than the strike price or, conversely, the current market price of underlying assets purchased by the seller may be considerably lower than the strike price (to which the seller committed)
- Barrier option buyer assumes a risk that the option purchased by the buyer might expire prior to expiration date (knock-out option) or may not be activated at all (knock-in option)
Example of risk
Below is an example of risk associated with a Call option
- Client purchases a currency option from the bank that gives him the right to purchase EUR 1 million/sell CZK, with expiration date in 1 month
- Agreed exchange rate (strike price): 27.565; the client pays option premium of EUR 4,300 to the bank
- On the expiration date, the current spot exchange rate is 26.565
- The client does not exercise the option – the client’s loss on the transaction is limited to the paid premium of EUR 4,300
Below is an example of risk associated with a Put option
- Client sells a currency option to the bank that gives him the right to sell EUR 1 million/purchase CZK, with expiration date in 1 month
- Agreed exchange rate (strike price): 27.565; the bank pays option premium of EUR 4,100 to the client
- On the expiration date, the current spot exchange rate is 26.565
- The bank exercises the option – although the client received a premium of EUR 4,100 from the bank, the client’s loss of CZK 1 million significantly exceeds the premium amount