Forex Online Option Trading
Get started to Forex options
Most of the people use to think about stock market when they hear about derivative product V options, Forex market also provide opportunities for the investors to trade this unique derivatives.
Forex Option Market Overview
For many traders Forex options are rapidly emerging an investment alternative tool. Forex options are eminent to professional Forex online option trading hedgers and traders. As an investment tool, Forex option trading is intended to provide trader with greater flexibility in their trading decisions. Forex options are utilized by major banks, financial institutions, commercial and individual hedgers and speculators.
Whereas some Forex option brokers offer only exotic "if touched" barrier currency option contracts that cannot be exited prior to expiration or payout, But some other brokers have access to plain vanilla currency option trading and efficient online execution. With one-touch order execution to buy and sell currency options, these traders receive streaming prices on vanilla currency options. Some broker offer forex options and spot Forex that can be traded from the same account, including mini contracts.
Definition of Forex Option
Forex online option trading can be defined as a Financial contract where the buyer of the option will have only the right, but not the obligation, to purchase or sell a specific Forex spot contract (underlying) at a specified rate (strike price) on or before a specified date (expiration date). The consideration amount paid by the buyer of the option to the seller is being called as the premium of the Forex option.
Buyer of Currency Option
The buyer or holder of the currency option contract has the choice to sell the contract before the expiration or he or she can hold the option contract until expiration and exercise his/her right to buy or sell specific currency from the market.
For getting this right under Forex option contract a buyer has to pay some amount as consideration called premiumto the seller. Please note that you may be also required to maintain a nominal margin (in addition to the premium amount paid to purchase option) if you are trading in the Forex spot contracts from the same accounts or if you may also be short selling the option positions.
Seller of Currency Option
Currency option seller can be called as writer or grantor of a currency option contract. The seller of the currency option contract has the contractual obligation to perform his part if the buyer exercises his right. In order to shoulder this obligatory risk only seller is getting premium from the buyer.
Te currency option seller initially itself will get his premium from the buyer (premium money will be transferred from buyers margin account to sellers margin account). The currency option seller must have funds in his account to cover initial margin requirements. If market moves in his favour, he will not be called to fund his margin account any more other than the initial margin requirement. However, if the markets move in an unfavorable direction for the currency Forex online option trading options seller, the seller may have to post additional funds to his or her currency trading account to keep the balance in the currency trading account above the maintenance margin requirement.
Just like the buyer, the currency option seller has the choice to either offset (buy back) the currency option contract in the options market prior to expiration, or the seller can choose to hold the currency option contract until expiration. If the currency options seller holds the contract until expiration, one of two scenarios will occur: (1) the seller will take the opposite underlying currency spot position if the buyer exercises the option or (2) the seller will simply let the currency option expire worthless (keeping the entire premium) if the strike price is out-of-the-money.
Please note that "puts" and "calls" are separate currency options contracts and are NOT the opposite side of the same transaction. For every put buyer there is a put seller, and for every call buyer there is a call seller. The currency options buyer pays a premium to the currency options seller in every option transaction.
Call Option
Call option will give the buyer/holder right to buy a specific currency at a specific rate on or before a specific date. In order to buy this option the buyer must pay premium to the seller.
Put Option
Put option will give the buyer/holder right to sell a specified currency at a specific rate on or before a specific date. In order to buy this option the buyer must pay premium to the seller.
There many two kinds of Options
These are being called as traditional options
*American options
* European option
American Option: - The specialty of this option is that the buyers of this option have the right to exercise the option any time before its maturity.
European Option: - The buyer of this option can have the right to exercise the option only on a specific date (expiration). These options cannot be exercised before the maturity date.
For eg: - if a trader purchase an option to buy Euro/USD at 1.2750 with a month maturity, such contract is know as Euro call/USD put. In option market, when a trader buy a call option, he simultaneously buys a put option alsoXsame like the cash market, where you buy a currency selling another currency.
Single Payment Option Trading (SPOT)
Here in this SPOT, a trader is initiating a scenario, for eg:- EURO/USD will breach 1.3000 barrier in another 30 days from todayK. He will obtain a quote for the premium, which has to be paid. If the spot of Euro/USD with in 30 days trades 1.3000 levels he will receive his payout. Essentially, SPOT automatically converts your option to cash when your option trade is successful, giving you a payout.
There are many traders who enjoy the benefit of SPOT option. If you are very closely following the Forex online option trading market and you initiate a trade through SPOT option, you will receive a good payout if market is in your favour. If you are not correct, maximum your loss will be the premium which you have paid for purchasing SPOT option.
The major disadvantage of this SPOT is nothing but the high premium compared to standard traditional options.
Advantage of Trading through option
* Your maximum loss will be the premium which you have paid for purchasing the option.
* Your profit potentiality is unlimited.
* You pay less money upfront than for a spot forex position.
* You have the choice to select/prefer the strike rate & expiry date.
* You can use option as a hedging tool against open position in spot forex in order to limit risk.
* Without taking much risk capital, you can use option to trade on predictions of market movements before fundamental events take place (economic reports or meetings)
* Spot option will give you more choice
1. Standard options
2. One-touch SPOT- you will receive a payout if the price touches a certain level
3. No-touch SPOT V you will receive a payout if the price doesnt touch a certain level
4. Digital SPOT- you will receive a payout if the price is above or below certain level
5. Double One-touch SPOT V you will receive payout if the price touches one of two set levels.
6. Double no-touch SPOT- you will receive payout if the price doesnt touches any of the two set levels.
There are several reasons for not being preferred by everyone for trading
* The option premium will vary according to the strike price & maturity of the contract, so the risk/reward ration varies.
* After buying SPOT option you cannot cancel it by selling.
* Its very difficult to predict the exact time and range break of a currency.
* You may be going against the odds.
Option pricing:- there are several factors to be included for pricing an option
1. Intrinsic value: - this is nothing but how much the option would be worth, if it were to be exercised right now. The position of the cuurent price to the strike price can be described in the following here ways.
* In the money
* At the money
* Out of the money
2. Time values V uncertainty of the price movement over a period of time. Normally longer the time period higher the premium will be.
3. Interest rate differential: - changes in the interest rate will have an affect in the relationship of strike price of the option & current market price.
4. Volatility: - higher the volatility higher will be the premium, because probability of hitting the strike price during the period is more.
How it is working
Assume on 2nd July 2006 Euro is trading at 1.2950, you have a view that the US number going to be released next week will be good for dollar and the pair will dip steeply, but you dont want to have a risky cash position, so you preferred to go for options.
You approached your broker and asking for a buy put sell call Euro/ USD with a strike price at 1.2900 with 10 days maturity from today, which is costing 10 pips. Date released was up to the expectation, and Euro/USD dipped to 1.2800 levels. You have exercised you option on maturity, when the spot was 1.2800 figure.
You net profit will be = ((strike price V spot price at the time of exercise)- premium you paid up front )* Quantum you bought
So, a profit of 90 pips you have earned in this volatility and your maximum risk was restricted to 10 pips (premium Amount)
Option strategies:-
This can be divided into two.
* Trading strategies: - buying option with a speculative mind, exposing you to a limited risk.
* Hedging strategy: - Options are a great way to hedge against your existing positions to decrease risk. Some traders even use options instead of or together with stop-loss points. The primary advantage of using options together with stops is that you have an unlimited profit potential if the price continues to move against your position.
Conclusion: - Even though they are difficult to use, it represents yet another tool which traders can use for making unlimited profit with limited risk. Option trading are especially prevalent when some important data are about to be released which can cause significant volatility.
Other Articles
