The prices of forex options vary depending on several factors. A single or a collective effect may determine the value of options. The first factor is what traders call the intrinsic value. It is the difference between the strike price and the underlying contract rate of the forex spot. This is the actual value of the option once exercised by the trader. It must be zero or above zero, never a negative numeral. A currency option with no intrinsic value is called “out of the money”, an option with value is called “in the money” and a forex option that has a strike price that is the same or very close to the rate of the underlying forex spot is called “at the money”.

The next factor affecting option prices is the time value, also called the extrinsic value. This is the uncertainty of price over time. It is generally considered that the longer the time, the higher the premium.

Another factor affecting value is the interest rate differential. This is basically the change in the interest rate that affects the relationship between the current market rate and the option strike price, which is commonly factored into the premium as a time value function.

The final factor is volatility. Most traders consider this to be the most important determinant of the price of options. It also measures movements of the underlying price. Greater volatility increases the possibility of the market value hitting the strike value within the limited period of time. It is typical that currencies that has greater volatility command higher premiums.

Source by Timothy Stevens