Option contracts for international money transfers

What is an option contract?

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 forward contracts. 

Let’s find out more about how it works below.

How does an option contract work?

Typically, a buyer or seller looking to exchange currencies would first seek to make an offer to an FX currency specialist, and specify a timeframe for their chosen option.

For example, you may wish to buy one currency and sell another at a certain point in the future, because you believe that one of the currencies will grow stronger than the other. 

An option contract would give you the right to buy the currency at a predetermined price, no matter how much the exchange rate has changed. 

The two main types of option contracts are referred to as a call option – which gives you the right to buy an asset at a predetermined price on a certain date – and a put option – which gives you the right to sell an asset for a predetermined price on a certain date. 

To give an example, a GBP to USD contract could give someone the right (but not the obligation) to sell £100 and buy $200 in three months' time. This would be a call option on USD and a put option on GBP. 

The pre-agreed exchange rate at which you could exercise the option, or strike price, would be 2 USD per GBP. In this scenario, if the rate fell below 2 USD per GBP, meaning USD was stronger, the option could be exercised, allowing the owner to sell at the higher rate despite the change to the exchange rate. 

When would you use an option contract? 

Businesses in particular might want to use an FX option to protect themselves from adverse changes in the currency market, which could affect the amount of money they receive in an international money transfer. 

For example, a company might have agreed to be paid a certain amount by another business (based abroad) on a future date. However, they may be worried about their currency devaluing before this date, in which case they would ultimately receive less money in the exchange. 

An option contract would give them the right to exercise the exchange of currencies at a higher rate in the future. However, they are not obliged to exercise the rate, giving them a benefit if the value of their home currency improves. 

This lack of obligation is what differentiates option contracts from forward contracts. With a forward contract, you set the time and date for the exchange, and it is exercised no matter what. However, with an option contract, you aren’t obliged to exercise the exchange at the strike price. 

Having said this, FX providers will charge a premium on the option contract, the amount of which will depend on various factors. You should always weigh up the flexibility of option contracts against the possibility of losing money on the premium.

Remember that FXcompared can help you compare currency providers to allow you to find the option contract that works for you – or alternatively, look at other options for hedging currencies (see our mega guide on managing foreign currency risk) 

So how would an option contract work in practice? Take a look at the case study below. 

Case Study: Selling a film prop to an overseas client

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.

Where can I find out more about option contracts?

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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