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20
Feb

What Is An Option

An option is a written agreement between two parties, which gives them the option to buy or sell an underlying commodity or asset at a specified price at a future date. While somewhat similar to a futures contract, an option grants the contracting parties the option to purchase or sell something. An option to sell the underlying asset is called a “Put Option.”

Essentially, the holder of the option has the right to decide to sell, or not sell, the asset on a specific date at a specific price, called the strike price. For example, ABC Company writes a forex put option to have the option to sell 1,000,000 Japanese Yen at a forex rate of US$00.001 on September 1st to the counterparty, XYZ Company.

If ABC Company chooses to exercise its forex put option, on September 1st it will sell 1,000,000 Japanese Yen at a forex rate of US$00.001 to XYZ Company, and XYZ Company must purchase those 1,000,000 Japanese Yen at a forex rate of US$00.001; regardless of what the actual forex rate is for Japanese Yen versus US Dollar at that time.

Conversely, if ABC Company had written a forex call option, for 1,000,000 Japanese Yen at a forex rate of US$00.001, with XYZ Company as the counterparty, then on September 1st ABC Company would have the option to demand that XYZ Company sell those 1,000,000 Japanese Yen at a forex rate of US$00.001 to ABC Company.

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