Updated on July 18, 2023
The term “exercise” refers to the act of utilizing or implementing an option contract. Options are financial derivatives that give the holder the right, but not the obligation, to buy or sell a specific amount of currency at a predetermined price (strike price) on or before a specified date (expiration date). The action of exercising an option involves executing the right to buy or sell the underlying currency as outlined in the contract.
Understanding Exercise in detail
When an option is exercised, the trader is essentially choosing to take action based on the terms of the contract. The specific action depends on the type of option involved:
Call Option Exercise – If a trader holds a call option, they have the right to buy the underlying currency at the strike price. When the trader exercises a call option, they purchase the specified currency at the predetermined price from the option writer (seller). This is typically done when the market price of the currency is higher than the strike price, allowing the trader to profit from the price difference.
Put Option Exercise – If a trader holds a put option, they have the right to sell the underlying currency at the strike price. When the trader exercises a put option, they sell the specified currency at the predetermined price to the option writer. This is typically done when the market price of the currency is lower than the strike price, enabling the trader to profit from the price decline.
How do traders decide on exercising an option?
The decision to exercise an option is based on the trader’s assessment of market conditions and their trading strategy. Factors such as the current exchange rate, market volatility, and time remaining until the option expiration date are taken into consideration. Traders may choose to exercise options if they believe it is financially advantageous based on their expectations of currency price movements.