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Currency Options Introduction As part of our ForexEarlyWarning trading plan service we are now providing currency options trading education. Using puts and calls on the spot forex can provide the currency trader with the following advantages:
Any ForexEarlyWarning subscriber can join us for our weekly forex webinar's where we will present the benefits of currency options and when and how to use them. If you would like to open up a demo or real account for combined spot forex and options trading in the same account you can do so using the link below. If you are a seasoned options trader or have experience with stock options we would like to welcome you to the world of currency options trading through ForexEarlyWarning. http://www.cfosfx.com/fxew.htm
Why Some People are Afraid of Options The general answer is ... a lack of education. People here others say options are “risky” or they hear jargon like “bull put spread” and get scared off. Its easy to criticize something you don’t understand. Options are for risk reduction, that’s why the professionals use them. Who Should Attempt to Trade Currency Options If you are a high level spot forex trader you should learn all there is about currency options. If you are still learning to trade the spot forex using multiple timeframe's and parallel and inverse, etc (Big Lights Method), or are just getting started, don’t worry about currency options just yet. Currency Options - Ten Key Terms Example transaction for the definitions below. The EUR/USD is trading at 1.5500 and use 1 regular lot for the trade size for all definitions below for simplicity. At-the-money - An option contract with a strike price at (or very close to) the underlying rate; also, the closest strike price to the underlying rate. If you purchase 1 call option at 1.5500 you bought a call at-the-money Exercise and Assignment - All puts and calls that are in the money are exercised the day of expiration the specified time with a spot position, there is no premature assignment. Out of the money options expire worthless. If you sell a covered call at 1.5500 on the EUR/USD and the price is above 1.5500 at expiration your spot position will be removed from your account and you will keep the premium. Hedge - The purchase or sale of options or futures contracts as a temporary substitute for a transaction to be made at a later date. Usually it involves opposite positions in the cash, futures or options market. If you buy 1 regular lot of the EUR/USD then 1 put option at 1.5500 you have a perfect hedge or married put. In-the-money - An option contract that has intrinsic value. If you buy a put option at 1.5500 and the EUR/USD drops, the put goes into the money. Intrinsic Value - The difference between the strike price and the underlying fx spot contract rate (American Style Options) or the fx forward rate (European Style Options). The intrinsic value represents the actual value of the option if exercised. Please note that the intrinsic value must be zero (0) or above - if an option has no intrinsic value, then the option is simply referred to as having no (or zero) intrinsic value (the intrinsic value is never represented as a negative number). If you buy a put option on the EUR/USD at 1.5500 strike price for a premium of $500 this is all time value and no intrinsic value. If the EUR/USD drops 50 pips and the options is worth $1000, $500 is time value and $500 is intrinsic value (in the money amount). Option Contract - A financial contract giving the buyer the right, but not the obligation, to purchase or sell a specific forex contract (the underlying) at a specific price (the strike price) on or before a specific date (the expiration date). The amount the buyer pays to the seller for the contract rights is called the "premium." This is for someone who buys a put or call. Option Premium - The amount the buyer pays to the seller for the rights of an option contract. Out-of-the-money - An option contract having no intrinsic value. EUR/USD trading at 1.5500, buy a put or call at 1.5500 strike price has no intrinsic value. If the EUR/USD rises above 1.5500 the option is out of the money. Strike Price – Exercise price. Uncovered - If you sell a put or call on the EUR/USD with no underlying spot position you are “naked” or uncovered. Don’t do this unless you understand the risk. For a more complete glossary click here http://www.cfosfx.com/forex_glossary.htm Currency Option Strategies Strategy #1 Selling Covered Calls Out of the Money Situation You currently own a spot position in the GBP/JPY (for simplicity 1 regular lot) that you bought at 211.00. The pair has moved up 200 pips but is stalling at resistance at 213.00 you think it will stall for a week or so then continue higher but you want to profit from this situation. Action: Sell a covered call at a strike price of 213.00 out 7-10 days to expiration, estimated premium would be about 2.00 which means: You are currently up about 200 pips on your spot position so this is $2000 in profit ($10 payout for simplicity), you get a premium of 2.00 which is another $2000 in profit. You just doubled your profit and are now guaranteed $4000 in profit if the GBP/JPY continues higher or stays just below 213.00. After you sell the calls out of the money there are three possible outcomes 1. The GBP/JPY consolidates below 213.00 for a couple of days but continues higher and you take no further action in your account. Your profit limit has a ceiling of $4000, if the GBP/JPY spot position continues higher you cannot profit from this and you are called out of your spot position at expiration. Maximum profit is $4000. Called out means that your GBP/JPY spot position will be removed from your account after expiration, you no longer own the GBP/JPY spot position after expiration, you were called out. 2. The GBP/JPY drops unexpectedly so you need to know your break even point because you own a spot position. Breakeven calculation, you bought the GBP/JPY at 211.00 and it is at 213.00, which is 200 pips of profit ($2000) after you sell the calls your breakeven price goes from 211.00 to 209.00. The selling of the call protects you by an additional 200 pips. You can install a price alarm and stop order at 209.00 to notify you of the price drop and subsequent liquidation of your spot position, you can also buy back your calls at that point. 3. If the GBP/JPY stays below 213.00 until expiration then starts to rise you keep the $2000 premium and additional profit from the GBP/JPY spot position rising. Your cost basis is now 209.00 and it can get extremely profitable here. Strategy #2 Selling Covered Calls In the Money and Buy-Writes Situation: You are a little late coming to the computer in the morning session but the GBP is strengthening across the board and is starting a new move. Action: Buy 1 regular lot of the GBP/USD at 1.9800 and sell covered calls at a strike price of 1.9750 for two weeks out. Estimated premium is 90 pips. $900 goes into your account. Check quotes it could be slightly lower. By comparison selling calls at 1.9800 would give you a $600 premium. After you sell the calls out of the money there are three possible outcomes: 1. The GBP/USD continues higher, you keep $400 net premium. 2. The GBP/USD goes sideways but stays above 1.9750. You keep $400 premium. 3. The GBP/USD unexpectedly drops significantly to below 1.9710 which is breakeven price. You could set a price alarm at 1.9720 and a stop order at 1.9710 for your spot position which is breakeven on the deal. If the GBP /USD keeps dropping you break even. Breakeven is 30 pips higher if you had sold calls at 1.9800. Strategy #3 Straddles on Volatile News Events Situation: You see a volatile news event coming and you don’t know which way the pairs will go so you buy a straddle to profit from movement in either direction. Action: Buy 1 put and 1 call on the GBP/USD at the money for an estimated cost of $1100 two days prior to the volatile news event ($550 each). After the news: 2. The GBP/USD goes sideways but does not move enough to produce a net profit, wait until expiration after the puts and calls expire and create a covered put or call from the position assigned. This will repair or minimize the loss that should have occurred Options Strangles Strangle – Buying equal amount of puts and calls at out of the money prices. Everything is the same as the EUR/USD example above however you would use a strike prices out of the money, so then your premiums would decrease. Benefits of straddles - Unlimited upside. Straddle certain news announcements that are historically volatile and put on the trade about 48 hours in advance at the money and make it expire the day of the announcement and closes out roughly 2 hours after the event regardless of the outcome. (MP) Below is the compiled statistics I got based on last 5 years statistics: 1. Non Farm Payrolls –Unemployment Average Move: 125 Pips Strategy #4 Put and Call Protection Situation: You see a volatile news event coming you own a buy position that is strongly profitable and want to protect the profits ahead of the news. Action: Buy 1 put option with custom expiration good for one or two days on the buy position. After the news if the spot position drops in value you are protected by the put, if the spot position goes up you lose the value of the put but the spot position increases in price. This is like an insurance policy on your profits. You can do the exact opposite with a sell position and a protective call option. Strategy #5 Demo Accounts and Demo Trading Go to this link http://www.cfosfx.com/fxew.htm and click on “free demo” in blue letters, you can have up to 10 demo accounts, and each one is good for two weeks. Demo accounts are great you can learn to get quotes and place orders without any risk. Another option is to go to this link again http://www.cfosfx.com/fxew.htm and click on “open a live account” in blue letters. There is a $2,000 minimum but this will allow you to have access to live streaming quotes without an interruption every two weeks. Then get a bound notebook and start papertrading Strategy 1, 2, 3, and 4 as well as other more advanced strategies in your journal. See if trading currency options is right for you. Judging The Possible Outcome of Options Trades. When judging their possible outcome of an options trade just enter the paper trade and track the underlying spot position. Did the pair go up, down, or sideways after you entered? Record the results in your journal book up to expiration. For example if you sell a covered call and the pair moves a lot higher you cannot lose money on this trade but will not participate in any further profit on the spot position. So no risk here. However if you sell a straddle and the pairs moves beyond the strike price of the puts or calls that you sold your account is now at risk, you must monitor this type of trade with price alarms or entry orders to manage the risk in case of the unexpected movement, so the risk scenario here is much higher than the covered call scenario in the paragraph above which has almost no risk Learning Resources If you would like to know more about trading currency options including the various strategies, terminology etc., go to the following link and then click on “trading tools yellow tab at the top of the page” and investigate all of the information in the drop down menu. as well as the following link: http://www.cfosfx.com/forex_options_broker_online_trading.htm#No%20Rollover If you have questions about the trading platforms you can contact CFOSFX Exercise and Assignment All puts and calls that are in the money are exercised the day of expiration at the specified time with a spot position, there is no premature assignment. Out of the money options expire worthless. Summary and Conclusions With currency options at our disposal we can now trade the spot forex when it is trending and occasionally trade puts or calls when the situation warrants it. As trend traders we know sometimes the market goes sideways with no trend and now we more weapons in our arsenal to profit from sideways movements in the market and strategies to protect our positions. We are looking forward to assisting our clients succeed with currency options.
*Disclaimer: Foreign exchange trading, foreign exchange investments and commodity futures trading and investments are not suitable for everyone. Forex trading and commodity futures trading carry a high level of risk and the possibility exists that you could sustain a loss of all or more of your currency trading or commodity futures trading investment. Before you decide to trade foreign currency options, trade foreign currency spot markets or trade commodity futures you should be aware of all risks associated with currency trading and futures trading. If you would like more information about the risks of forex trading, commodity futures trading and of online forex trading and online futures trading, please contact a CFOS/FX futures and forex broker to discuss online foreign currency trading risks and/or commodity futures trading risks in detail. |
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Forex trading involves substantial risk of loss and is not suitable for all investors. Read Full Disclosure
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