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Foreign Exchange Option (FX Option)

What is “Foreign Exchange Option”?

  1. It is a purchase and/or sale contract established by using foreign exchange rate as the trading subject matter. It grants the buyer the right to purchase or sell a fixed amount in a specific currency from the seller of the contract according to the strike price specified for performance in the contract in advance. The buyer of the contract can choose to purchase call option or to purchase put option in order to perform the terms of the option contract with the seller of the contract. The buyer pays the premium to obtain the right for requesting the seller to perform the contract, and the seller is required to bear the obligation for performing the contract due to the collection of the premium.

Product Characteristics

  1. The buyer of option needs to pay premium, and the payment of the premium is similar to the payment of premium for insurance purchase. The effect of financial security can also be obtained. 
  2. The buyer of option can exercise such right when the foreign exchange rate change is favorable to the buyer; whereas when the foreign exchange rate fluctuation is beyond expectation, the buyer can withdraw to exercise such right. Therefore, for the buyer of options, it is of the characteristic of both “offense and defense at the right time,” thereby understanding and utilizing the trend of foreign exchange rate to avoid risks. 
  3. The seller of option can collect premium upon the establishment of the contract in order to regulate the cash flow, and it can also combine with the foreign currency deposit to form a foreign currency structured product, thereby increasing rate of return of the product. 
  4. Once the buyer of option submits the right to exercise the contract, the seller of option has the obligation to perform the purchase or sale of the subject currency according to the contract, such that it needs to bear the risk associated with the conversion of strong currency into weak currency or the risk associated with the compensation for loss in foreign exchange rate difference.   

Relevant Requirements for Undertaking Options by Our Bank

  1. Transaction subject: Customers having business dealings with our bank (including OBU and DBU). 
  2. Transaction currency: Transaction subject matters with foreign exchange rate of USD to NTD, EUR, JPY and GBP. Options in other foreign currencies are handled according to the market condition and customer needs. 
  3. Term of contract: Maximum length is limited to one year. 
  4. Transaction limit: There is no limit when customers making purchase of options. However, when customers are selling options, it is necessary to apply for relevant limit with our bank before the transaction in order to execute such sale upon approval. 
  5. Settlement method: Customers can choose difference settlement or real settlement. However, for NDO in USD to CNY, it can only choose USD for the difference settlement.  

Type of Options

  1. Options can be classified into the following types according to trade pattern:
    1. Call Option: Customer has the right (not obligation) to purchase a certain amount of currency at a specific price on (or before) a certain day. 
    2. Put Option: Customer has the right (not obligation) to sell a certain amount of currency at a specific price on (or before) a certain day.  
  2. Options can be classified into the following types according to the complexity of option contract:
    1. Plain Vanilla Option: For NTD exchange rate option, only this type of option can be selected for handling. 
    2. Exotic Option: There are a great variety of types of exotic options, and the options available for undertaking by our bank generally include:   
      1. Knock-Out Option: When the spot exchange rate reaches a certain exchange rate, then such option becomes invalid immediately. 
      2. Knock-in Option: When the spot exchange rate reaches a certain exchange rate, then such option becomes valid immediately. 
    3.  Double Barrier Option: Options having two barrier exchange rates at the same time.