Forex Options
Learning About Trading Forex Options
By Peter Flemming
Forex options are one method of invest forex traders can use to make money. Forex options give the purchaser the right, but not the requirement, to buy or sell a certain currency at a particular rate. Once used only by major banks and corporations, brokers now offer this service to individual traders.
Forex options lock the price of a currency for a certain amount of time. Timelines range anywhere from one month to six months. Along with locking in a price, options also states the number of currency units that must be sold. An investor can sell their option at any point within the time frame of the option.
When investors buy forex options, they are hoping that the exchange rate of a currency will fall by the expiry date. Say an investor purchases 1,000 options at the rate of USD/GBP=0.5074 with an expiry date of 5 months. The trader that buys these forex options will hope the value of the Pound falls or the value of the Dollar rises. If, at any point within the expiry date, the currency pair looks something like USD/GBP=0.5813, a profit has been made. You get to sell the Pounds at the better rate while everyone else must pay the other rate. If not all works out and the value of the pound rises above the option rate, the purchaser is under no obligation to sell his options. The only loss comes from the premium that was paid to purchase the options.
Of course there are drawbacks to options. One is the premium that must be paid. Depending on the type of currency and the amount of forex options purchased, rates will differ. When a forex investor purchases options, he is hoping that the exchange rate will fall enough to overcome the premium paid as well as make a profit. Using forex options is a great way for serious investors to guard against setbacks.
There are rules that must be adhered to when purchasing options. The main rule is to play the odds in your favor. Forex options can be compared to horse racing. Though the potential for profit is largest with the horse that has the greatest odd, the chance of that horse winning is slim. Betting on the horse that has the better odds will not net as much money, but is more likely to make you a profit. Getting obsessed with potential profit lures many investors to options, but playing against the odds is likely to result in a loss.
You can get the odds in your favor by buying options close to the strike. This means buying options close to the money or in the money. If, by the expiry date, your options are not in the money, you will lose your premium. Buying close to the strike will not make you a killing, but is more likely to result in a financial gain. The amount of small profits made will eventually add up.
Another way to get the odds in your favor is to get time on your side. Buying forex options close to an expiry date will hurt your profit potential. The more time you have, the more likely you will make money.
Forex options are a great way to make profits, but must be used with caution. Beginning traders can forget about the risk options pose, just like betters can bet foolishly on the horse with high odds. Avoid unnecessary risk. Follow the strategies above to increase the chance of turning a profit.
Peter Flemming is a professional Forex Trader and is a staff writer for a forex trading website about learning forex trading and trading education. Download a copy of our free forex ebook today!
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