Options are one more tool that could be harnessed in forex trading. These securities can potentially help manage the risks involved with the global currency markets. Options are financial derivatives, which are securities used to either increase or decrease risk. By entering one of these contracts, a participant is wagering on a certain outcome. If you are looking to learn more about derivatives and their use in both investing and risk management, options may be a good place to start, as they can be simpler than many other derivatives contracts.
In this article, we will help build the foundation so you can learn about options and how they pertain to forex trading. An option is a contract that grants the holder the right, but not the obligation, to either buy or sell an underlying asset or market factor during a specific time frame.
Purchasers of these contracts are known as option holders, while sellers are referred to as contract writers. After acquiring an option, a buyer can either exercise the contract, sell it or let it expire. The seller, on the other hand, is at the mercy of the buyer. At this point, you might wonder why a person or organisation would want to give someone else rights to its securities. The answer is that by writing a call or put, the individual or entity can earn income in exchange for granting such rights.
Investors interested in forex trading can use options in an effort to try to meet their investment objectives. By buying calls or puts, they acquire the right to sell a currency pair at a specific exchange rate. In contrast, writing options on these underlying assets can generate income for sellers. In this instance, you could buy a call on this pair with a strike price of 1.
Therefore, you will have the ability to either sell the contract for a profit or exercise it and purchase the currency pair for 1. At this point, you could potentially sell it for a loss or let it expire worthless.
If the currency pair is trading at 1. In the event the pair appreciates, the put you purchased will lose value.
Writing call and put options can provide investors with income. However, it can also generate losses. If forex traders want to harness a basic options writing strategy, they can sell call options on assets they own, which creates income. This strategy, referred to as covered calls, is viewed by many as being less high risk, as the risk is limited. Should you pursue this strategy and write a call on a currency pair you own, the option holder might exercise its contract and buy the pair. In the event this happens, your risk is limited to the rise in value the underlying asset experienced, minus the income you brought in.
Many perceive this approach to be highly risky. If you provide someone the right to purchase a currency pair at a certain price and the pair surges in value, you could incur substantial losses.
Fortunately, many brokers will not allow investors to write naked calls unless they have a large balance in their account or have accumulated substantial experience. For those who want to generate income from puts, selling currency puts could help them achieve this specific objective, if the value rises.
Generally, investors write puts on securities in the belief they will rise in value. If a forex trader sells a put on a currency pair they think will appreciate and this forecast comes true, they can simply collect the premium without having to worry about the holder exercising the contract.
Should the pair fall in value, the forex trader who wrote the put may find himself having to buy back the currency pair at a fixed price, which could result in a loss.
One simple example of this nature is the risks and rewards associated with purchasing call options. If an investor believes a currency pair will rise in value, buying call options reflecting that belief can generate far greater returns than purchasing the pair outright. While buying options comes with limited liability, selling options contracts has potentially unlimited liability.
If an investor sells a naked call, he could face unlimited losses. Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice.
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The FXCM Group assumes no liability for errors, inaccuracies or omissions; does not warrant the accuracy, completeness of information, text, graphics, links or other items contained within these materials. Registered in England and Wales with Companies House company number Options Defined An option is a contract that grants the holder the right, but not the obligation, to either buy or sell an underlying asset or market factor during a specific time frame.
Forex Trading Investors interested in forex trading can use options in an effort to try to meet their investment objectives. Writing Options Writing call and put options can provide investors with income. Past Performance is not an indicator of future results.More...