• A forward currency option is the option to exchange currency at a point in the future at the rate it is in the present. This means that the holder of a currency can hedge against fluctuations in the market while also avoiding commitment to a future sale. However, this privilege comes at a premium.
  
  

Buyers

• Investors use options if they think a currency could substantially change in value in either direction.This is because a currency option gives them the opportunity to exchange at a present exchange rate. For example, if an exchange rate for a certain currency is 1:1 in January and an investor signs an option to use that same exchange rate in July, he is best served by a change in the exchange rate. If it changes to 2:1, he can buy at the January price but sell at the July price, thus netting a substantial profit.
  
  

Sellers

• Options sellers have the opposite perspective. They are not speculating or hoping for currency rate changes, but rather are aiming for a steady profit. If the market value of the currency rises to above the agreed-upon option rate, then the options seller has to pay the option's rate.
  
  So if the agreed-upon rate is 1:1 for US$1,000 to CD$1,000 (Canadian dollars), but the market value changes to 2:1, the options seller still has to exchange at the agreed-upon rate. The buyer benefits because he can exchange at 1:1, according to the options agreement, then exchange his CD$1,000 for US$2,000 on the open market.
  
  

An Example

• The hypothetical exchange rate between the U.S. and Canada is 1:1 in January. Knowing he is going to need Canadian dollars in July, an investor signs an option agreement for his $1,000. This means that in July he can exchange $US1,000 for $CD1,000, regardless of the market value. In exchange for this privilege, he pays $10 a month, or $60 total.
  
  Assume the U.S. dollar's value falls in July and the exchange rate becomes 1:0.75. Were he to exchange his currency at current prices, he would lose $250 because his $US1,000 is now only worth $CD750. However, since he has a futures option he can exchange his $US1,000 for $CD1,000.
  
  Alternatively, assume the U.S. dollar's value rises to 1.5:1. He is not obligated to exercise his option, and instead buys $CD1,500 with is $US1,000.
  
  The options seller lost $190 in the first transaction, as he made $60 in fees while losing $250 by being forced to exchange at a below-market rate. In the second transaction, however, he made $60.