An Option is a contract whereby the buyer has the right but not the obligation, to buy (call) or sell (put) a certain amount of the underlying within (American option) or at (European option) a specified deadline (Expiry date), at a level of predetermined price (strike price).
In order to obtain this right, the buyer of the option has to pay the other party a price.
To give a concrete example of an action based option, the buyer of the European call option on the ENI action at 10 Euro means that, at the expiry date, the customer will have the right to buy the ENI stock at 10 Euro. Obviously everything will be reversed as the right to sell at a certain price (strike) at a certain date, in the case of a put option contract.
The Call and / or Put options can be purchased on regulated markets where the features are standardized, or can be purchased on the Over The Counter market and in this case the liquidity is guaranteed by a bank or a broker.
So an option can have any currency cross as an underlying and is commonly used to hedge the exchange rate risk.
An example may help to understand how it works.
A 100,000 purchase of an European Call Eur Put Usd option with a strike price 1.3050 expiry date 3 months from the signing of the contract, requires the payment of a price of 0.0150. In this case, the buyer will pay the price for the right to buy EurUsd at the change of 1.3050 (strike price) in case EurUsd at the expiry date is higher than the strike of 1.3050, while he will not exercise any right if it is lower than the strike price. In this case, the break-even point for the buyer will be represented by the sum of the strike price (1.3050) and the price (0.0150), or 1.3200.
What really makes the value of an option
In order to calculate the theoretical value of an option, there are several complex models that depend on the following variables:
The price of an option is composed by 2 parts:
OPTION VALUE = TIME VALUE + INTRINSIC VALUE