Similar to an insurance policy, this “hedging instrument” lets you exchange currency on a fixed date, at an exchange rate set in advance (exercise price). It eliminates the risk associated with the spot market for your future transactions, but doesn’t require you to execute if the spot price at the future time is more favourable than your option’s exercise price. European options allow you to exercise an option only on the expiry date, while American options allow you to do so at any time between the purchase date and the expiry date.
There are two types of option contracts: put options and call options. They allow you to sell or buy a certain amount of a specified currency at a set exercise price for the period in question.
Apart from options in Canadian dollars, you can buy options in foreign currencies for a minimum of US$100,000. As with any type of insurance, purchasing an option involves an initial cost, or “premium”, which is determined by the exercise price, the expiry date, and the volatility of the currency at the time of the purchase. There are no other transaction costs or commissions for you to pay.