Forex options trading is an alternative way to spot fx to speculative or hedge the price movements of a particular currency pair. With Currency Options, the trader has the option, but not the obligation to buy or sell a currency pair at a specified date in the future.
Buying currency options contracts will have an initial fee. If at the date of expiry the traders position is in profit, the trader takes the profit. In this situation the net profit will be the contract value on expiry minus the cost of the contract.
Alternatively if the position is negative on expiry there are no losses to pay, the only loss is the cost of the contract.
FX options can be ideal if you feel a particular forex pair is about to move in a specific direction, but you are not sure when it will happen. A forex options contract can be held in this instance and presuming price hits your target before expiry, you have the opportunity to profit, regardless of how far price moves in the opposite direction before expiry.
Traders also have the opportunity to sell foreign currency options. This is different from shorting a particular currency pair. As mentioned above, when you buy an options contract, you pay a fee or “premium” for the contract. You can also take the other side of the contract, by receiving the premium and paying if the contract ends in profit. Selling currency options and options in general involves considerable risk as the maximum profit is the price of the premium but the maximum loss is potentially infinite. Selling options is not recommended for new traders, as clearly the potential losses are huge.
Currency Options Strike Price
Forex options contracts have a strike price. This is the price at which a specific currency contract can be exercised. This is effectively the “entry”. Selecting a strike price further away in a favorable direction to your position will usually result in a smaller premium. For example let’s say the spot price for GBP/USD is currently $2. A call option on GBP/USD with a strike price of $2.02 will cost less than a strike price of $1.98.
Currency call option
A call option is where the buyer of the contract will profit if the price of the currency pair increases. The seller or writer of the contract will be obliged to pay the profit of the underlying contract to the buyer if it expires in profit.
Currency put option
A call option is where the buyer of the contract will profit price of the currency pair decreases. The seller or writer of the contract will be obliged to pay the profit of the underlying contract to the buyer if it expires in profit.
Out of the money
A call option is referred to as out of the money when the strike price is higher than the market price of the the particular currency. Conversely, the reverse is true for a put option, they are “out of the money” when the strike price is lower than the market price. A call option is referred to as “in the money” when the market price is higher than the strike price. The same is true for a put option when the market price is below the strike price.
Forex Options Strategies
There are many different strategies that options traders use, some of them very complex. Some of the simple ones include:
Long Strangle
This is where a call and a put option are simultaneously bought. This strategy can be used when a lot of volatility is expected, so you can profit no matter which way price moves. The maximum loss will be if price doesn’t move at all, you will incur the loss of two premiums.
Bear Call Spread
It is entered by buying call options at a certain strike price and selling the same number of call options of lower strike price (in the money) on the same currency pair with the same expiry date. This strategy has both limited profit and limited loss. It is best used when the trader is moderately bearish.
Forex Options Brokers
There are many brokers that allow you to trade currency options, popular ones include:
