Forex Options Trading
Forex (fx) is an acronym of Foreign Exchange. Forex Trading is the act of trading currencies from different countries against each other.
Forex option trading is different from regular forex trading. When an owner is buying or selling actual currencies, this is known as forex trading or currency trading. However, in forex option trading, the owner is buying the option not the currency i.e. they are entering into a contract to buy or sell currencies at a fixed price within a specified time frame.
A forex option is a type of binary option which means that the payout is determined when the contract is created i.e. the potential gain and the potential loss from the trade is known from the offset. There are only two possible outcomes: or the option expires in-the-money and the owner receives a fixed amount of cash; or the option expires out-of-the-money and the owner receives nothing. However, if forex option trading is carried out with anyoption™, an owner receives 15% back if his option expires out-of-the-money.
In forex options the underlying asset being traded is a currency pair – hence why they are also called currency options. These could take on numerous possibilities: EUR/GBP, AUD/USD, USD/JPY, GBP/JPY and more.
Receiving a payment when trading forex options is independent of the magnitude by which the price of the currency moves. For example, an owner may buy a call option for £100, expiring at the end of the day, for a return of 70% on the currency pair USD/EUR currently at 0.7037.
If at the end of the day, the currency pair ends at 0.7041 then the option has expired in-the-money and the owner will receive £170. They receive the full 70% payout, regardless that the stock only moved 0.04 points. This demonstrates the relative simplicity of trading forex options.
Over the past 2 decades the forex option trading market has exploded, with individuals entering a previously elite industry. They understand how learning a small amount about different currencies can lead to potentially huge profits with all risks being calculable in advance.
To explain Forex Options, it’s important to explain what an option is. An option is a contract which gives the buyer (known as the owner) the right, but not the obligation, to buy or sell an underlying security at a fixed price within a specified time frame.
An underlying security could be currencies, stocks, commodities and indices. It is the item which is being traded. This fixed price is the price at which a security is bought or sold at – in currency option trading it is known as the strike price.
There are two types of option strategies: Call and Put.
In a call option, the owner may buy a quantity of an underlying asset at the strike price within a specified time frame.
The buyer of a call option believes the market price of the asset will rise above the strike price. If this happens, then the option (or contract) allows the owner to buy the asset at the strike price which is lower than its current price. This means the asset can be bought below its market value and the owner can profit from the difference.
In a put option, the owner may sell a quantity of an underlying asset at the strike price within a specified time frame.
The buyer of a put option believes the market price of the asset will fall below the strike price. If this happens, then the option allows the owner to sell the asset at the strike price which is higher than its current price. This means the asset can be bought below its market value and the owner can profit from the difference.
There are several benefits of forex option trading which is why many investors favor it over other options:
the risk is limited to the amount purchased in the option an investor can pay less money to enter into a deal and the possibility of profiting is high the risk is known from the offset, since the maximum an investor can lose is the money he deposited for the trade.
However, once an option has been bought, it cannot be sold so the decision to trade is final. Also, it is difficult to predict the market so an investor must be careful and considerate when trading options.
Initially, currency trading was only accessible to wealthier customers who could afford to trade with large quantities of currencies. However, due to the introduction of online trading platforms, such as anyoption™, profiting from currency option trading, even for small investors, is possible and achievable. Online option trading also enables people to invest whilst in the comfort of their own home. They can trade from wherever they are geographically, without the need for a broker.
The foreign exchange market (also known as the currency exchange market) is where currency trading takes place. It enables banks, financial institutions and individuals to buy and sell foreign currencies. What this means, is that one of the parties can buy a quantity of a one currency in exchange for buying a quantity of a different currency.
Currency values fluctuate, enabling forex trading to take place. This is when a trader pre-empts the direction that a currency will go in, to hopefully yield high returns. If a quantity of a currency is bought at a set price and its value increases, then the trader can sell the currency at a later date for the new higher price and profit from the difference. A forex trader’s goal will be to gain from foreign currency movement.
Currency trading is sensitive to economic and political factors, resulting in a forever unpredictable market. Hence the potential for capital gains can be huge, if a currency is traded wisely.
How are the rates of currencies represented?
Currency rates are represented relative to one another i.e. how much of one currency is needed to buy another.
They are quoted in pairs.
For example, USD/EUR = 0.7037. This means that it costs 0.7037 Euros to buy 1 US dollar.
The first currency, in this case the US dollar, is known as the ‘base’ and it is always written first and with a value of 1. The second number is the ‘quote’ currency and it shows the price for 1 unit of the base currency.
Forex trading becomes more interesting as the strength of currencies begin to change. In our example above, if the US dollar becomes stronger, then the quote currency rises, since it will take more Euros to buy 1 dollar, or alternatively, for each 1 US dollar, a trader will receive more Euros.
Similarly, if the US dollar weakens, then the quote currency goes down, and it costs less in Euros to buy one US dollar, or for each US dollar you will receive less Euros.
What does this mean for the average person on the street?
This could affect a person is several ways. Take the pair USD/EUR where the Euro applies to someone living in France:
A strong US dollar means that a Frenchman will find it more expensive to buy US imports since each dollar’s worth of goods will cost more Euros that it did previously. Similarly, an American travelling to France will find it ‘cheaper’, since for every dollar that they exchange, they will get more Euros in return and will therefore have more Euros to spend for what they may have received when the US dollar was weaker (i.e. when the ‘quote’ currency was lower)