We are independent & ad-supported. We may earn a commission for purchases made through our links.

Advertiser Disclosure

Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.

How We Make Money

We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently from our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.

What Is an Average Rate Option?

By John Lister
Updated May 16, 2024
Our promise to you
SmartCapitalMind is dedicated to creating trustworthy, high-quality content that always prioritizes transparency, integrity, and inclusivity above all else. Our ensure that our content creation and review process includes rigorous fact-checking, evidence-based, and continual updates to ensure accuracy and reliability.

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

Editorial Standards

At SmartCapitalMind, we are committed to creating content that you can trust. Our editorial process is designed to ensure that every piece of content we publish is accurate, reliable, and informative.

Our team of experienced writers and editors follows a strict set of guidelines to ensure the highest quality content. We conduct thorough research, fact-check all information, and rely on credible sources to back up our claims. Our content is reviewed by subject matter experts to ensure accuracy and clarity.

We believe in transparency and maintain editorial independence from our advertisers. Our team does not receive direct compensation from advertisers, allowing us to create unbiased content that prioritizes your interests.

An average rate option is an options contract based on currency rates over a period of time. This contrasts with most currency options that are based on the price on a specific date. The main use of an average rate option is to minimize the risk of losses caused by currency fluctuations.

An options contract is an agreement between two parties. The first party pays a fixed fee, or premium, to the second party. In return for this payment, the first party has the right but not the obligation to carry out an exchange at a future date. Naturally it will only do so if circumstances mean the exchange is to its benefit.

The simplest form of options contract related to currency exchange rates is for the option to involve a currency exchange at a fixed rate on a future date. When that date comes, the party with the option to make the exchange will usually look at the actual market exchange rate to decide if it is worthwhile exercising the option so that it can make an immediate profit. Some more complicated versions of a currency option allow the first party to exercise the option at any time up to the agreed date, not just on the date itself. As this increases the chances the first party will be able to exercise the option at a favorable rate, the premium payment will usually be higher with this type of deal.

Not all people or organizations that use currency options do so as a form of speculation. A business that deals with overseas clients will often use a currency option as a form of hedging. For example, if a business is supplying an order to an overseas client and is scheduled to receive payment in six months time in a foreign currency, it will be uncertain how much that money will actually be worth in domestic currency when it is received. Using a currency option can protect the business against the currency rate moving in an unfavorable way in the meantime. The business will consider the premium a price worth paying to remove uncertainty and risk.

The average rate option works in a slightly more complex way, and is usually carried out between a business and a bank. Under the average rate option, the business pays a premium and designates a sum of money, an exchange rate and a future date. On this future date, the bank calculates the average actual exchange rate over the period of the contract. If the actual rate is lower than the designated rate, the bank pays the business an amount. This amount is equivalent to effect the difference between the average and designated rate would have on the designated sum.

Although the concept of an average rate option is more complex, from the perspective of the business it appears simpler. This is because there is no need to actually buy or sell any currency: the business pays a premium, and then either gets a cash payment at the end of the period if the exchange rate has been lower than expected, or no money changes hands if the exchange rate has been as expected or higher. In effect, the option simply acts as an insurance policy, paying out if exchange rates are undesirably low.

SmartCapitalMind is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.

Discussion Comments

SmartCapitalMind, in your inbox

Our latest articles, guides, and more, delivered daily.

SmartCapitalMind, in your inbox

Our latest articles, guides, and more, delivered daily.