When thinking about options, the most people think about the regular stock market. That is also the most usual place to do options trading, but it is also possible to do forex options trading.
Forex is the foreign exchange market. On the forex, currency pairs are traded. Using options the trader gets an opportunity to limit his risk and/or to increase the profit.
For forex traders, there are normally two types of options available. The most common is the normal call or put option. The call/put option works like the call/put options on the stock market. But on forex there is a second alternative available, it is called SPOT — Single Payment Option Trading.
Traditional options give the buyer the right to purchase the underlying value at a certain price and at a certain time. For example it is possible to buy an option allowing the buyer to by three lots of EUR/SEK at 10.6 in three months. This would be known as a EUR call or a SEK put. If the value of the EUR/SEK is above 10.6 the buyer can buy the 3 lots for only 10.6, regardless of how much they are worth. If he then sells them directly after he has bought them, he has made a great profit. Of course, if the value of the EUR/SEK doesn’t rise above 10.6, the option is regarded worthless. But the buyer did in this case only lose his premium, i.e. his loss was limited and thereby also the risk.
There are two types of traditional options on the market today:
1) European style — this option can be exercised only at the time of expiration
2) American style — can be exercised at any point in time up until expiration
Single Payment Options Trading
SPOT options work a bit different than the traditional options. In this case the trader believes that a specific scenario will happen. One scenario could be that the SEK/EUR will break 10.6 in 12 days. The trader can make a SPOT that works exactly on this condition. If the SEK/EUR breaks the 10.6 barrier in 12 days, the trader will get receive his payout. If not, he loses his premium.
Normally SPOT options are more expensive than traditional options. The advantage with SPOT options is that they are much easier to trade and that you can easy trade a lot of different scenarios.
The reasons to trade options are of course as many as the number of people trading them, but the most common reasons are:
– The profit potential is unlimited
– The risk can be limited and easily calculated
– Less money involved as when trading normal forex positions
– Hedge positions — used against an open position to limit risk
Before using options you have to learn some basic terminology about options trading. For example, Intrinsic value and Volatility.
There are a lot of places on the internet where you can find even more information about forex options trading and there are also books treating this subject.