A lot of people usually think of stock options when talking about Forex options trading. FOREX options can actually be other things than stocks such as commodities, indices and even currencies. Many investors nowadays use FOREX options as an alternative investment to increase their profit. To increase the profit, investors should know what these FOREX options are and know how to use them in order to take advantage of the volatile market and the stable rates of range-bound markets. In order to comprehend more of the FOREX options trading, one should think of it as an insurance policy where in it is valid and effective when certain conditions are met.
FOREX option trading is a contract between a buyer and a seller where in the buyer has a right over a specific amount of currency at a predetermined price and time. In return for this right, the buyer will pay a premium or a one-time sum to the seller.
The buyer has the right to sell or keep his position until the expiration date. If the buyer exercises his right to buy the spot position at a strike price, then he is called a call buyer. If he is to sell the spot position at a strike price, he is called a put buyer. A strike price is the set rate the buyer can either buy or sell the underlying currency when doing option contract. If the strike price exceeds the spot rate by enough points to cover the worth of the premium and if the strike price falls behind the spot rate by enough points that cover the worth of the premium, the buyer will make a profit. Usually, the higher the difference between the strike and spot price, the lower the price of the option (premium) because it has lesser chance of hitting the strike price.
If the market price moved in favor of the buyer, the buyer can take the difference between the market price and the strike price. However, if it does not, the position is closed and the buyer will lose the premium. The only financial obligation of the buyer is to pay the premium to the seller.
There are two primary types of FOREX options trading. one is the traditional call or put options and the other is the single payment option trading or SPOT. The latter gives traders more flexibility.
In the traditional option, the buyer has the right (but is not obliged) to purchase something from the option seller at a set price and time. For example, the trader may purchase an option to buy three lots of EUR/USD at 1.4000 in one month. This contract is known as “EUR call.USD put”. If ever the price of the EUR/USD is below 1.4000, the buyer losses his premium and the contract is worthless whereas if the price skyrocketed to 1.5000 then the buyer can exercise his options and gain three lots for only 1.4000 which can be sold for a profit.
Brokers offer two types of traditional options. These are American-style and European-style. The American-style can be exercised at any point before expiration while the European-Style can be exercised at the time of the expiration.
The good thing with the traditional options is that it has a lower premium than SPOT options. The only problem is that traditional options are more difficult to set and execute.
In the Single Payment Options Trading or SPOT, the trader will put up a scenario. For example, EUR/USD will break 1.4000 in 12 days. The trader will obtain a premium quote or option cost and receives a payout if ever the scenario takes place. The SPOT automatically converts your option to cash if the trade is successful.
The good thing with SPOT options is that they can be traded easily by just making a scenario. If you fail a certain scenario, then you lose your premium. If not, then you gain a profit. Another good thing with SPOT options is that it offers varieties of scenarios that you can choose from thus providing much flexibility than the traditional one.
The only problem with SPOT options is that it has a higher premium- more than the standard options.
These are the things that you need to know about FOREX options trading.
