for delivery at a future time. Notional – the amount of each currency that the option allows the investor to sell or buy. Ratio of notionals – the strike, not the current spot or forward. Numéraire – the currency in which an asset is valued. Non-linear payoff – the payoff for a straightforward FX option is linear in the underlying currency, denominating the payout in a given numéraire. Change of numéraire – the implied volatility of an FX option depends on the numéraire of the purchaser, again because of the non-linearity of . In the money – for a put option, this is when the current price is less than the strike price, and would thus generate a profit were it exercised; for a call option the situation is inverted. Trading The difference between FX options and traditional options is that in the latter case the trade is to give an amount of money and receive the right to buy or sell a commodity, stock or other non-money asset. In FX options, the asset in question is also money, denominated in another currency. For example, a call option on oil allows the investor to buy oil at a given price and date. The investor on the other side of the trade is in effect selling a put option on the currency. To eliminate residual risk, traders match the foreign currency notionals, not the local currency notionals, else the foreign currencies received and delivered do not offset. In the case of an FX option on a rate, as in the above example, an option on GBPUSD gives a USD value that is linear in GBPUSD using USD as the numéraire (a move from 2.0000 to 1.9000 yields a profit), but has a non-linear GBP value. Conversely, the GBP value is linear in the USDGBP rate, while the USD value is non-linear. This is because inverting a rate has the effect of , which is non-linear. Hedging Corporations primarily use FX options to hedge uncertain future cash flows in a foreign currency. The general rule is to hedge certain foreign currency cash flows with forwards, and uncertain foreign cash flows with options. Suppose a United Kingdom manufacturing firm expects to be paid for a piece of engineering equipment to be delivered in 90 days. If the GBP strengthens against the over the next 90 days the UK firm loses money, as it