Option contracts give a buyer or seller the right (but not the obligation) to execute an exchange of a particular currency at a predetermined rate at or by a future date.
Option contracts cost money whether they are executed or not, but they can provide additional benefits compared to limit and stop-loss orders and forwards contracts. Let’s find out how it would work with the case study below.
Business issue: If a company plans to make or receive a foreign currency payment in the future, but is not certain the payment will happen or how large it will be.
Business goal: Using an option contract to protect against a currency decline
An Australian special effects company, OZeffects (OZE), agreed to build a new film prop in three months’ time for €500,000 for a movie being shot in France.
Worried about possible exchange rate moves against the Australian dollar (AUS), OZE decided to enter into a currency option called a ‘protection option’ and paid a small premium. This allowed OZE to set a worst-case rate to protect the company from the rate declining, but also allowed OZE to benefit if the rate improved. OZE was able to fix a worst-case AUS to EUR rate of 0.6901.
Without the protection of an ‘option’, if the rate had moved to 0.6766, OZE would have received A$6,750 less for their prop. However, on the settlement date, the rate had moved to 0.6886, increasing OZE’s sale amount by a further A$6,000.
To find a provider who offers option contracts, you can conduct a comparison search on our site or head to our reviews section, where we’ve looked more closely at several companies who offer services for managing currency risk.
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