As a direct comparison between the rate of a forward currency contract and the break-even price for a currency option (when adding its strike price and the premium paid), the option contract will usually be more expensive than the forward contract. But that is to be expected. In a currency option the company has a choice that is not available in a forward contract. On the other hand, if the exchange spot rate moves further than the strike price (the intrinsic value), the owner of the option can earn a profit.

Currency options as a means of hedging a commercial exchange risk have not yet reached the same level as forward contracts for many reasons. This market does not have the same depth and liquidity as the forward currency market and it is therefore more difficult for the banks to hedge options compared to forward contracts making the options more expensive. However, if the bank can use a currency option towards a customer as an additional hedge for an existing imbalance in its own portfolio, or as a counter-trade against another transaction, the bank may price the option accordingly.

The option market is understandably also more traded and liquid for the larger currencies used in international trade and for shorter periods, although together with an increased use for commercial purposes, currency options might become more and more competitive. It is estimated that 510 per cent of all commercial currency hedges are completed today in the form of options. However, the company should always check the alternatives and see the currency option as only one of several methods, which combined should hedge the overall currency position. The option may be more expensive but, in conjunction with other hedges, it can be worth the cost. Currency risk Management Currency derivates A currency derivate is a generic term for specific types of products that banks and other currency traders derive from the basic exchange rates. The main types of derivates that have been described in this chapter are: currency swaps; currency forwards; and

However, currency derivates, and in particular currency options, are often constructed by banks and currency traders in a number of different ways, depending on the purpose, and can for larger amounts often be tailormade for a specific transaction.