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It frequently happens that the party concerned is uncertain as to the exact date when payment will be made or received.

 
For example, an exporter may wish to cover against the possibility of a few days' delay in the transfer of funds by the buyer, or an importer may wish to cover against late receipt of shipping documents from the exporter.
 

In this case, the party concerned will enter into an Option Forward FX Contract. This is also variously known as Value Date Option or Option-Dated Forward Contract.

 With this the party concerned is not tied to a specific payment date, but can deliver currency during an agreed period in order to settle the FX contract.
 

If, for example, an exporter is expecting to receive payment in 2/3 months' time but is not certain of the exact date, then an Option Forward FX Contract may be entered into which includes an option to provide the currency at any time within that 2/3 months period.
 

An importer who is uncertain as to precisely when they will have to make payment can also enter into an Option Forward FX Contract to permit him to take delivery of the purchased currency anytime during an agreed specified period.
 

It should be emphasised that the term "option" is not an option to the trader as to whether or not they need fulfil the contract. It is an option only over the timing of settlement of payment. Once the forward contract has been entered into both parties are obliged to fulfil it.
 

When the trader wishes to take out forward cover with an option on the period for settlement, the bank will quote a rate for the option period that is most favourable to itself.

 
Example - Option Forward FX Contract - Exporter Sells

An exporter contracts to sell US Dollars in two months' time with an option to deliver the currency over the third month.
 

We need to compare the bank's buying rate for two months with that for three months.
 

The US Dollar is at a discount to
 

                                            2 months              3 months
Spot Rate                             1.4150                 1.4150       

Add Forward Discount       0.0070                  0.0090

                                               1.4220                   1.4240
 

THE BANK BUYS HIGH AND SELLS LOW
 

As the bank is buying the $, the higher rate will be more favourable to itself (the seller has to deliver more US Dollars). Therefore it will quote the rate of $US1.4240/ £1.

 
The principal disadvantage of the Option Forward Contract, is that the exchange rate will typically be the poorest available from the company's point of view during the period of the option.
 

If it was an importer buying US Dollars, the bank would quote $US1.4220 in order to supply the importer with the fewest dollars per pound Sterling.