Suppose you’ve had your eye on the perfect house for you and your family.  Maybe it’s something you drive by on your way to the office.  One day, as you pass, you see a FOR SALE sign in the front yard.

So you stop and ask how much.  Unfortunately, the price ($200,000) is well above what you can afford to pay right now.

But you really, REALLY want the house, so you ask the seller if you could rent it with an option to buy.  He agrees, and offers you a contract to rent with an option to buy the premises later on.

The terms are set:  you pay $1,500 a month rent for 2 years plus a one-time payment of $3,500 for an option to buy the house for $200,000 any time during the contract.

You can’t raise the two hundred grand to buy right now.  But property prices are rebounding in this neighborhood, and you figure the house will be worth $225,000 to $250,000 in a couple years’ time. 

Since you still only have to pay $200,000 to exercise your option, you can use that extra equity to float a bigger loan then than you can now.

If during the next two years the price of the house rises above $200,000, the difference is pure savings to you.  And if the price falls below the $200,000, the option will be worthless and you would choose to buy the house at market value -- or simply continue renting.  Your total possible loss:  the $3,500 you paid for the option to buy and not a penny more -- EVER.

There you have it:  an example of an option from real life.  Just substitute a currency -- like the Euro, Canadian dollar, yen, or British pound -- for the house and the “savings” for profits and you’re looking at currency options.

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