CHAPTER VI FOREIGN CURRENCY OPTIONS Foreign currency options—sometimes referred to simply as currency options—are options to purchase or sell one currency at a price denominated in another currency. The price of one currency in terms of an- other currency is known as an exchange rate. The exercise price of a currency option thus represents an exchange rate. The currency in which the premium and exercise price are denominated is referred to as the trading currency. The currency to be purchased or sold at the exercise price is the underlying currency. Certain of the foreign currency options discussed in this chapter. which are referred to as dollar-denomi- nated foreign currency options, are options to pur- chase or sell underlying foreign currencies for U.S. dollars, and their exercise prices represent the ex- change rates of the underlying foreign currencies with respect to the U.S. dollar. Other options (which are referred to as cross-rate foreign currency options or cross-rate options) that are discussed below under "Cross-Rate Foreign Currency Options" are options to purchase or sell an underlying foreign currency at an exercise price that is denominated in another foreign currency. The exercise price of a cross-rate option therefore represents an exchange rate between two foreign currencies. While most of the foreign currency options that are traded at the date of this booklet are physical delivery options, trading has been introduced in cash-settled foreign currency options. These options are dis- cussed below under "Cash-Settled Foreign Currency Options." The term "foreign currency" includes not only the currencies of individual nations, but also the European Currency Unit ("ECU"). The ECU, which is composed of specified amounts of various European currencies, is the official medium of exchange of the European Economic Community's European Monetary System and is primarily intended for use in international com- merce. As used