A foreign exchange option, which is also known as a currency option, is nothing but a currency derivative with which the user gains the right to purchase or sell a pair of currencies at a certain set price, known as the strike price, on a specified date.
However, keep in mind that the user doesn’t have an obligation to do so. If you know the basics, then you know the value of a currency is always measured against another one, and there are several factors that can lead to the fluctuation of these prices.
So, if you are ready to trade forex now, let’s dive into this article and get to know some interesting facts about the same.
Benefits of a Currency Options
There are several benefits of purchasing a currency option, and we have listed some of them below –
- The downside risk of the buyer is always limited to a certain position, and hence, they are always aware of their worst position.
- The buyer is also aware of the maximum cost at the outset. This is because while making the payment upfront, the buyer has to pay not only the premium but also the funding cost.
- Everything depends on the buyer’s choice – they can choose the expiry date, the strike price, and even the amount.
- The buyer is not under any obligation to exercise the option at the strike price and hence exchange the currency. They can choose to allow the option to simply lapse over if that is in their favor. If you are interested in forex trading, you must check out such tactics.
- You can take out the options any time you like.
- With any one option contract, if the user prefers to hedge the risk involved due to currency exposure, they can set multiple delivery dates for certain specified amounts.
- Options trading for forex is available for almost all major currencies and even for the smallest of amounts. You need not hold a fortune to get started.
- You can adopt any strategy that you feel would suit your needs the best.
Drawbacks of Currency Options
Now let us have a look at the drawbacks of currency options which are not as many as the advantages. But to maintain a balanced approach, you must know both the advantages and the disadvantages –
- Whenever you are purchasing the options, they must be paid for in full then and there. You cannot delay the payment.
- In the case of tailor-made options, it is often noticed that there is a lack of negotiability.
- Even though you will get options in all major currencies, it is also true that you will not get them in all currencies that are present on the exchange.
- Hedging through currency options often turns out to be a costly affair.
- The buyer might simply forget to exercise their option at times.
How to Trade Forex Options?
These are the steps that you need to follow –
- Firstly, you need to make sure that trading forex options is the way you want to step into the world of forex trading. Once you have figured that out, it is time for the next step.
- The next step is to learn more about the options trading market in general and how it works. These details will help you make more informed decisions.
- Then, from over eighty currency pairs that are out there, you have to pick the pairs that you want to trade in. Some major currency pair examples include USD/JPY and EUR/USD.
- After that, you will have to open a trading account if you don’t have it already. You need a CFD account to trade options, and here, you only need a small deposit which is ideally the premium of your options. This will help you open your position in the market.
- Now, you have to choose your forex option and also the timeframe. If you are bullish, then you will purchase a call, but if you are bearish, then you will purchase a put. The timeframe depends on the platform you have opened your account on. Most platforms will offer you different types of timeframes.
- Next is picking your strike price, which is one of the most important steps. Do some additional research on what factors you must consider when choosing the strike price. After that, you simply have to monitor your position and stay on top of everything that is happening in the market and how it is affecting the price movement.
By now, you probably have a pretty good idea about the forex options market. So, what are you waiting for? Go and explore and make the best out of currency fluctuations!