How to trade forex options – FX Options Explained

You can trade currency using options, instead of betting on the spot price. This allows you to define your total risk, going into the trade. For example, you can buy a call option, which gives you profit if the markets break above a specific level, or you can buy a put option which gives you profit if the markets fall below a specific level. You can also sell both of those options in order to benefit from the market not getting there. There are a whole host of various strategies to go far beyond the scope of this article but suffice to say options are a great way to mitigate risk going into a trade.

It should be noted that the only true options exchange is the CME Group in Chicago. Yes, there are liquidity pools that will match up options just as they will spot Forex and are regulated. However, they are not true exchanges and there is a bit of a difference.

Calls and puts

There are two different types of options, known as “calls” and “puts.” A “call” is betting that the market is going to rise in value while a “put” is the opposite, betting that the market is going to fall in value. The great thing about options is that you buy one of these at a set price and cannot lose any more than the agreed to value of the premium paid. If the market does not do what you want it to do, you simply lose whatever you paid, and the option expires worthless.

However, some people will sell these options, which is a little bit trickier, but does generate income. For example, if you sell a “call” with a strike price of 1.11, meaning that it pays off above that level, and the buyer pays a premium of $300 at the time you are selling, you get to collect at $300. However, it is worth noting that if the trade goes against you, it is likely that your losses will start to accelerate at an exponential value. In other words, it can be quite expensive if you hang on to that position. However, it is a great way to collect premium from a longer-term standpoint, as long as you know basically where the market is not going to go.

Strike price and expiration

Options have both a strike price, meaning where they are geared to and where they pay, and in expiration. Quite often you will see something like a strike price of 1.17 in the EUR/USD, and the expiration can be anything from minutes to hours, days to weeks. Be aware of when the expiration is because the value of the option starts to deteriorate much quicker the closer you are to the expiration if not “in the money”, which means that the market has reached whatever price was expected. If it is getting late in the option life, this is statistically calculated based upon the likelihood of the option becoming valuable.

Hedging

A lot of longer-term Forex traders will buy puts on a long position they plan on holding to for quite some time. For example, if you believe that the Euro is going to rise against the dollar over the next five years, occasionally buying a put is a cheap way to keep yourself in the market. If you buy a put for $200, and the market goes against you and hits the put strike price, you may be able to mitigate quite a bit of your losses from the longer-term “buy-and-hold” spot Forex trade. Worst case scenario, you lose the $200 that you had bought for “insurance purposes.”

Options in general

There are hundreds of options strategies, and that clearly is beyond the scope of this video or article. However, we wished to introduce you to the concept as options are most certainly an unbelievably valuable strategy for those looking to play the market from a longer-term standpoint, or simply defined their risk ahead of time. By being aware of this market, it can expand the way you trade currencies.

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