What is the primary advantage of currency options over forward and futures contracts?

The primary advantage of currency options over forward and futures contracts is that they provide the right, but not the obligation, to exchange currency. This flexibility allows the holder of the option to choose whether to execute the contract based on market conditions at expiration. If the market moves favorably, the holder can exercise the option to take advantage of the beneficial exchange rate. However, if the market does not move in their favor, they have the choice to let the option expire, thereby limiting their potential losses.

In contrast, forward and futures contracts obligate the parties involved to exchange the currency at a predetermined rate on a specified future date, regardless of market conditions at the time of expiration. This feature of currency options makes them particularly appealing for risk management and speculative strategies, as they allow for participation in favorable market movements without the risk of being required to transact under less favorable conditions.

Overall, the option to exercise or not provides a strategic advantage, making currency options a valuable tool for managing exchange rate risk.