An option that gives the holder the right, without the obligation, to exchange a specific amount of money denominated in one currency into an amount denominated in another currency at a preset exchange rate (exercise rate) on a specified date (expiration date). For instance, a yen/ dollar option contract may give the holder the right to sell 83 million Japanese yen (JPY) and buy 1 million US dollar (USD) on March 10. As such, the underlying exchange rate is USD/ JPY 83, and the notional amounts are JPY 83 million and USD 1 million. This option can be viewed as a call option on dollars, and hence is labeled USDJPY call, and a put option on yen, and hence is denoted JPYUSD put. If at expiration date, the exchange rate turned out to be less than USD/ JPY 83 (say USD/ JPY 80), that is the yen has appreciated against the dollar, then the option would be exercised so that the holder sells yen at USD/ JPY 83, and immediately buys yen back at USD/ JPY 80, making in the process a net profit of

JPY 83 million – JPY 30 million = JPY 3 million

The foreign exchange options market is the largest and most liquid options market worldwide. Though foreign exchange options are usually traded on organized exchanges and over the counter, most trading takes place over the counter where regulations are very light and relatively relaxed.

Foreign exchange options are also known as FX options, forex options, or currency options.