Advantages

• To hedge against foreign exchange rate risk arising from trade exposures (export/import).
• To hedge against foreign exchange rate risk arising from foreign currency investments or funding in any currency.
• To provide cover against contingent exposures like foreign currency tenders.

Example: Call Option


If the spot rate is USD/INR = 46.00 and when the Option strike price is:


• 45.85 :  It is called In the Money Option (ITM)
• 46.00 :  It is called At the Money Option (ATM)
• 46.10 :  It is called Out of the Money option (OTM)

Factors governing premium

• Volatility:  Greater the volatility, higher the premium.
• Tenor:  Longer the tenor, higher the premium.
• Strike Price: Premium differs for ATM, ITM & OTM contracts.

Regulations

Customers having genuine foreign exchange exposure can buy options to hedge their exposures. While selling of naked options by customers is prohibited, RBI has permitted customers to enter into cost reduction structures, which involve simultaneous buying and selling of options.