Today, there are multiple security types available to profit from this trading strategy:. The second option of euro forex futures offers the benefits of low capital requirement because of margin trading available on futures, but comes with the inherent requirement of daily margin money maintenance.
For more details on futures margin money requirement, see Margin Requirements. The third choice involving Forex options offers the benefit of low capital requirement, but without the overhead of margin requirements like futures. This article discusses how forex options work, and how to trade forex currency pairs through options with examples. Other details include a list of most common currency pairs for forex options trading and risk - return profile.
Call and put are two basic option types. Each option has a predetermined strike price defined at the time of trade as a part of the option contract.
Each option also has a predetermined expiry date , after which it ceases to exist. A trader has a bullish view that this rate will go higher in one month by June This is the amount that a forex trader has to pay for buying one contract in EURUSD call options plus brokerage charges. The original bullish view of the forex call option buyer did not hold true, and therefore he suffers a loss. The buyer of this forex call option is in profit. He benefits on the price differential of 1.
Effectively, the payout from the forex option contract depends upon the relative difference between strike price and the underlying forex spot prices at the time of expiry. The higher the underlying spot prices above the strike price , the higher the payout for a call option. Below the strike price, the buyer gets zero payout, leading to loss of premium. The RED flat horizontal line represents scenario C1, where the forex spot price ending below the strike price of 1.
Scenarios C2 and C3 are represented in the slanted GREEN line, which indicates that higher the underlying forex spot price, the higher the payout. The forex put works the other way around for the put buyer. The original bearish view of the forex put option buyer came true, and thus he benefits. The lower the underlying price goes below the strike price of 1. The moment the spot price moves above the strike price, there is zero payout from put option and put buyer loses the option premium RED graph.
Call and put options offer profit payouts in an inverse relationship to underlying forex spot rates. If a buyer believes that the underlying forex rates will increase further by the expiry date, she should buy a call option.
The put option is the best choice for the opposite view. The sellers will benefit from the opposite price move. If his assumption comes true, he gets to keep the entire option premium scenario C1 above. If his prediction comes true, he gets to keep entire option premium scenario P2. If otherwise, he pays the buyer scenario P1.
In essence, the option seller has limited profit potential — capped to the option premium collected. But loss potential is infinite and variable. Additionally, selling options requires margin money to be maintained, which is another complex requirement on a daily basis. Only experienced option traders with substantial capital should take short sell positions in options.
For the novice, the long call and long put positions offer sufficient exposure as needed. It is not necessary to wait until expiry to benefit from a profitable option position. The option prices the premium keep fluctuating every second depending upon a number of factors.
Introduction and Option Pricing: Factors That Influence Option Price. Instead of waiting until expiry, one can simply trade buy-sell options and benefit from premium differentials, if bets are placed right. Long positions in forex options allow low cost exposure. A forex rate change of only 4. Long positions in options are also better than futures trading.
Options magnify the profit exposure with limited capital, but without the mandatory requirement of maintaining daily margin positions, as in futures. The situation is worse if one short sell options — the loss can be much more than the traded amount. Instead of holding until expiry, one can actively trade with well-defined profit and stop-loss targets. The risks can also be mitigated by using efficient capital allocation techniques that structure how much money to bet per trade.
For example, properly structured trading plans might enable having four straight loss-making trades in a row, and covering up for them in the fifth trade with overall profit. The most common and heavily traded currency pairs include the Australian dollar , the British pound , the Canadian dollar , the Euro , the Swiss franc , the New Zealand dollar , and the Japanese yen , all against the US dollar.
The same currency pairs have the highest liquidity in the forex options market. NASDAQ offers forex options trading on seven major currency pairs, enabling trading opportunities to both retail and institutional traders. Traders should note that JPY option contract specification differs slightly from other currency options, owing to its higher currency denomination.
The popularity of options trading continues to grow at the individual and institutional levels. The payouts from correctly placed long option forex trades are very high, with the benefit of limited loss potential.
However, short option positions should be avoided by novice traders, because they may lead to very high losses, even much larger than the trade value. In-depth study leading to complete familiarity with options pricing and function is mandatory for option trading. Understanding the factors affecting option valuation, followed by thorough practice on free demo-trading accounts, is advisable for option traders, before making big bets in forex options trading ventures.
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Become a day trader. Today, there are multiple security types available to profit from this trading strategy: A Quick Primer on Options Call and put are two basic option types. Here is an example with graphical representations. This phenomenon is represented graphically as follows for a call option: This phenomenon is represented graphically as follows for a put option: Trading Forex Options It is not necessary to wait until expiry to benefit from a profitable option position.
Factors That Influence Option Price Instead of waiting until expiry, one can simply trade buy-sell options and benefit from premium differentials, if bets are placed right. The Forex Options Market The most common and heavily traded currency pairs include the Australian dollar , the British pound , the Canadian dollar , the Euro , the Swiss franc , the New Zealand dollar , and the Japanese yen , all against the US dollar.
The Bottom Line The popularity of options trading continues to grow at the individual and institutional levels. No thanks, I prefer not making money. Get Free Newsletters Newsletters.More...