This week marks the end of a very volatile October of forex options. The options market saw solid movements this past month as the U.S. dollar showed a sharp decline against the major currencies as well as against gold bullion.
TheLFB’s Forex Option Corner will be launched as a stand-alone service offering over the coming month, and will include an on-line forex option Training Academy course, as well as an introduction to option nuances, charting packages, and a signal service.
The following interview with DFXG.com’s Trade Desk Director, Mr Jerry Khargi, reveals the potential in the upcoming month of forex option trade.
Forex option buyers saw many opportunities to capitalize on this trend by employing such fundamental strategies as going outright Long Eur/Usd Calls, (an option that gives the holder the right to buy the underlying instrument at a specified price during a fixed period), or even being Long a Eur/Usd Bull Call Spread.
Bull Call Spread: An option spread designed to exploit rising asset prices by purchasing a call option with a low exercise price and selling a call option with a high exercise price. Thereby being long one call option with a strike price near-the-money, and short one call option with an out-of-the-money strike price. A hedged position, to some extent, that will still profit if the initial trade direction follows through.
At this time an option trader can strategize on the play for November Vanilla expiration, (Vanilla is a simple option whose terms and conditions do not include any provisions other than exercise style, expiry and strike, compared to exotic options which have additional terms).
As it currently stands, the option volatility skew coming from the market makers would suggest the following;
Usd/Jpy volatility is weighted more towards a decline in price, as the volatility of the Puts increases more rapidly than that of Usd/Jpy Calls, suggesting a Jpy bias.
The Eur/Jpy parity also shows the same volatility skew, as the Eur/Jpy puts carry a heavier premium, suggesting an expected decline.
Gold Bullion is skewed to the upside as the Calls are being weighted for a more volatile move, suggesting that the market participants are pricing in yet another move up for the precious metal.
Gbp/Usd has been the currency pair with the widest movements lately, consistently showing a wide intraday range. Buyers of Gbp/Usd options found it advantageous use the less risky option play, versus the pure spot currency play which was susceptible to stops being triggered before the expected move occurred.
In volatile pairs that have this amount of wheel-spinning movement it is far better to take the spot stop loss amount and invest that in time. In other words, use the stop loss amount as the premium to purchase the option.
Traders could buy an option and have unlimited profitability, while limiting the loss to the premium paid, as opposed to taking a spot position on margin, where the risks are certainly steeper when intra-day volatility is rife.
Bang for the buck looks to come from the November 19th expiration on the Gbp/Usd pair, and playing any impending U.S. dollar decline towards the end of the year. Looking at the long $1.6200 Gbp/Usd Calls, at a premium of 122 pips. The delta (percent chance of this strike being in the money on expiration) is roughly 30 on this particular strike price which is currently about 300 pips out-of-the-money.
If Gbp/Usd rallies from the current price then the value of the option (considering time remaining to expiry) would increase. We would look to close the option if the movement we are looking for occurs rapidly.
Holding on until expiration, our position would be worth its intrinsic value (every pip above 1.62 would be what this position is worth). If Gbp/Usd settles at 1.6300 then the position would be worth 100 pips.
We can also employ a bull call spread strategy, where we purchase a $1.5900 Gbp/Usd Call at 250 pips (which is at-the-money at this time) and simultaneously sell a $1.6200 Call and receive 115 pips in premium from that. The net result of this trade would be paying 135 pips (paid 250 pips, then received 115 pips) to own this spread.
If Gbp/Usd settles above $1.6200 on expiration, then we would own a long Call at $1.5900 and also a short spot position at $1.6200 (the position sold that generated the 115 pip premium payment turns into a spot position on expiry).
This would naturally net out to 300 pips, and considering that we paid 135 pips to buy the spread, the profit would be a net 165 pips.
If Gbp/Usd settles below $1.6200, then the short 1.6200 Call will expire worthless, and the value of this spread would be the amount of pips above $1.5900 that Gbp/Usd settles; the intrinsic value.
For Example: if Gbp/Usd settles at $1.6100, then the long $1.5900 Call would be worth 200 pips.
With the Volatile nature of the Gbp/Usd pair, we can also see value on the opposite view point of potential Usd strength, and sterling weakness.
In this case we would buy a Gbp/Usd Put for the same expiration date as the previous two examples.
We would buy a $1.5600 Gbp/Usd Put, which gives us the right to be short Gbp/Usd in the Spot market at the stated strike price $1.5600. This option would cost roughly 140 pips. The delta of this option shows about a 30% chance of settling in-the-money at expiry.
We can also use a Bear Put spread strategy, which is the opposite of our Bull Call spread, as we own the right to be short the Gbp/Usd.
Bear Put Spread: A spread designed to exploit falling asset prices by purchasing a put option with a high exercise price and selling a put option with a low exercise price. Thereby being short one put option with a strike price near-the-money, and long one put option with an out-of-the-money strike price. A hedged position to some extent that will still profit if the initial trade direction follows through.
We would purchase a 15850 Put at 229 pips and simultaneously sell a 1.5550 Put receiving 117 pips in premium, this spread nets out to a cost of 112 pips. If Gbp/Usd settles below 1.5550 on expiration, then the spread would be worth 300 pips, realizing a profit of 188 pips.
With about 37 days to realize the movements we seek, either of these strategies would prove to be effective, given each traders take on the actual market.
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