Foreign exchange options are a relative unknown in the retail currency world. Although some brokers offer this alternative to spot trading, most don't. Unfortunately, this means investors are missing out. FX options can be a great way to diversify and even hedge an investor's spot position.
Or, they can also be used to speculate on long- or short-term market views rather than trading in the currency spot market. Structuring trades in currency options is actually very similar to doing so in equity options.
Putting aside complicated models and math, let's take a look at some basic FX option setups that are used by both novice and experienced traders. Basic options strategies always start with plain vanilla options.
This strategy is the easiest and simplest trade, with the trader buying an outright call or put option in order to express a directional view of the exchange rate. Placing an outright or naked option position is one of the easiest strategies when it comes to FX options. Basic Use of a Currency Option Taking a look at Figure 1, we can see resistance formed just below the key 1.
We confirm this by the technical double top formation. This is a great time for a put option. An FX trader looking to short the Australian dollar against the U. Premium of pips. Profit potential for this trade is infinite.
But in this case, the trade should be set to exit at 0. Preferred by traders, spread trades are a bit more complicated but they do become easier with practice. The first of these spread trades is the debit spread , also known as the bull call or bear put. Here, the trader is confident of the exchange rate's direction, but wants to play it a bit safer with a little less risk. In Figure 2, we see an This is a perfect opportunity to place a bull call spread because the price level will likely find some support and climb.
Implementing a bull call debit spread would look something like this:. The Credit Spread Trade The approach is similar for a credit spread.
But instead of paying out the premium, the currency option trader is looking to profit from the premium through the spread while maintaining a trade direction. This strategy is sometimes referred to as a bull put or bear call spread. Learn more about this and other spreads in Option Spread Strategies.
With support at So, the trade would be broken down like this:. As anyone can see, it's a great strategy to implement when a trader is bullish in a bear market. Not only is the trader gaining from the option premium , but he or she is also avoiding the use of any real cash to implement it. Both sets of strategies are great for directional plays. Option Straddle So, what happens if the trader is neutral against the currency, but expects a short-term change in volatility?
Similar to comparable equity options plays, currency traders will construct an option straddle strategy. These are great trades for the FX portfolio in order to capture a potential breakout move or lulled pause in the exchange rate. The straddle is a bit simpler to set up compared to credit or debit spread trades. In a straddle, the trader knows that a breakout is imminent, but the direction is unclear.
In this case, it's best to buy both a call and a put in order to capture the breakout. Will the spot rate continue lower? Or is this consolidation coming before a move higher? Since we don't know, the best bet would be to apply a straddle similar to the one below:. It is very important that the strike price and expiration are the same. If they are different, this could increase the cost of the trade and decrease the likelihood of a profitable setup.
The potential profit is infinite — similar to the vanilla option. The difference is that one of the options will expire worthless, while the other can be traded for a profit. In our example, the put option expires worthless pips , while our call option increases in value as the spot rate rises to just under The Bottom Line Foreign exchange options are a great instrument to trade and invest in. Not only can an investor use a simple vanilla call or put for hedging, they can also refer to speculative spread trades when capturing market direction.
However you use them, currency options are another versatile tool for forex traders. Dictionary Term Of The Day. A conflict of interest inherent in any relationship where one party is expected to Broker Reviews Find the best broker for your trading or investing needs See Reviews. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance.
Become a day trader. The Forex Market FX options can be a great way to diversify and even hedge an investor's spot position.
So, how is this done? Premium of pips Profit potential for this trade is infinite. FX Trek Intellicharts This is a perfect opportunity to place a bull call spread because the price level will likely find some support and climb.
Implementing a bull call debit spread would look something like this: So, the trade would be broken down like this: Figure 3 exhibits a great straddle opportunity.
Since we don't know, the best bet would be to apply a straddle similar to the one below: A conflict of interest inherent in any relationship where one party is expected to act in another's best interests. Passive investing is an investment strategy that limits buying and selling actions.
Passive investors will purchase investments How much a fixed asset is worth at the end of its lease, or at the end of its useful life. If you lease a car for three years, A target hash is a number that a hashed block header must be less than or equal to in order for a new block to be awarded.
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