The Pricing of Currency Options

The two options markets, OTC and exchange traded, are competitors to some extent, but they also complement each other. Traders use both markets in determining the movement of prices, and are alert to any arbitrage opportunities that may develop between the two markets.
Dealers in the OTC market may buy and sell options on the organized exchanges as part of the management of their own OTC positions,hedging or laying off part of an outstanding position in an exchange market.

The Pricing of Currency Options '
It is relatively easy to determine the value of a European option at its expiration. The value of a
European option at expiration is its intrinsic value—the absolute amount by which the strike price of the option is more advantageous to the holder that the spot exchange rate.

If at expiration the strike price is more advantageous than the spot rate of the underlying, the option is “in the money”; if the difference between the strike price and the spot rate is zero, the position is “at the money”; if the strike price is less advantageous than the spot rate, the option is “out of the money.” Determining the price of an option prior to expiration, on the other hand, is much more difficult.

Before expiration, the total value of an option is based, not only on its intrinsic value (reflecting the difference between the strike price and the then current exchange rate), but also on what is called its time value, which is the additional value that the market places on the option, reflecting the time remaining to maturity, the forecast volatility of the exchange rate, and other factors.