Extrinsic Value

The premium of an option that has no intrinsic value is made up solely of time value. Time value reflects the uncertainty of an option being exercised at expiry.

The time value of an option is a function of:

  1. The relationship between the strike of the option and the current market forward rate
  2. The time period of the option
  3. The interest rate differential
  4. The expected volatility in the underlying currency-pair.

Relationship between strike and current market forward rate

The time value of an option will be at a maximum when the strike price of an option is equal to the current forward rate. At that point, the degree of uncertainty surrounding whether or not the option will be exercised will be at its highest level.

As an option moves further "into the money" the time value of the option will fall as the probability of it being exercised increases. Similarly, if the option moves further "out-of-the-money" the time value of the option will also fall as the probability of it not being exercised increases.

Time Period

In general, the longer the period of an option, the greater its potential pay-off and therefore the more expensive it will be. While the amount of time value of an option will increase as the maturity lengthens it will do so at a decreasing rate.

Interest Rate Differentials

The interest rate differential between the two currencies in any particular option affects the option premium by affecting the relationship between the strike of the option and the current market forward rate. Any movement in the interest rate differential that shifts the underlying option further in-the-money will make the option more expensive; any movement that shifts it further out-of-the-money will make it cheaper.Volatility

The expected volatility in the underlying exchange rate is the most important variable in pricing a currency option. The higher the volatility the greater the potential for large exchange rate movements and hence the greater the potential pay-off of an option. Consequently, higher volatility will translate into higher premiums for both puts and calls.

Option traders often differ in their expectations of future volatility. Influencing a traders expectations will be the historical volatility of the particular currency pair (i.e. its recent track record), the potential impact of future news and data releases on the currency, the relative demand for options, other traders expectations and any other factors that the trader feels could materially affect future movements in the currency.

Make an enquiry
* Denotes a mandatory field.
(Country code/Area code/Number)

Currency Converter

select
select
Rate: 1.0062
=
Rate: 0.9938
=
Go
See My FX Dashboard for more info

Register Free

Registration is quick and easy. Access live customer rates, free tools and make international payments.

Register today
Already registered? Login
Get free rate alerts
 / 

: Choose ccy pair and enter the exchange rate. An alert will be triggered when the exchange rate is reached and an email will be sent to you. You can unsubscribe any time and your email address is safe – see our Privacy Policy.
Get our free commentary
Commentary: Stay on top of the news with updates from our expert dealers on the latest currency movements. You can unsubscribe any time and your email address is safe – see our >Privacy Policy.
Keep me up to date: RSS

Mobile Forex trading tools

Make money transfers or currency conversions on the go via our mobile site, iPhone or Android apps. Learn more here

Banners

Sitemap

You're in good hands:

© 2011 Copyright CanadianForex Limited

The CanadianForex service is owned and provided by CanadianForex Limited [CN: 674939-9] ("CanadianForex"). Any reference on this page to "we", "us", or "our" is a reference to CanadianForex.

CanadianForex is part of the global OzForex Group and is a wholly owned subsidiary of OzForex Pty Ltd (ACN: 092 375 703), an Australian company, whose shareholders include Accel Partners and the Carlyle Group in the US, and Macquarie Bank in Australia.
 
Where any information is provided by CanadianForex, it is done so without considering the investment objectives, financial situation and particular needs of any person. Before acting on any general advice, you should consider its appropriateness to your circumstances. To the extent permitted by law, CanadianForex makes no warranty as to the accuracy or suitability of any information and accepts no responsibility for errors or misstatements, negligent or otherwise. Any quotes given are indicative only. The information may be based on assumptions or market conditions and may change without notice. No part of the information is to be construed as a solicitation to make a financial investment.

DISCLAIMER: CanadianForex makes no warranty, express or implied, concerning the suitability, completeness, quality or exactness of the information and models provided in this web site. Read full disclaimer.

CanadianForex provides international money transfer services to private clients and business customers. Use our free currency converter, exchange rate charts, economic calendar, in-depth currency news and updates and benefit from competitive exchange rates and outstanding customer service.