Posted by forex at 4:22 AM
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1. Assess the outlook of the currency market conditions. Assume the two currencies at issue are the U.S. dollar and the British pound. In a currency option, because buying one currency is selling another currency at the same time, each currency has to be labeled as either a call or put in the same option. Other options identify only the option itself as a call or put. Depending on which way the exchange rate between the dollar and pound is expected to move, exchange the dollar for the pound or exchange the pound for the dollar.
2. Sell an option to open a position. If future exchange rate seems to favor the dollar over the pound, a trader would want to sell an option that is a call on the pound and thus a put on the dollar, giving the option buyer the right to buy pound and sell dollar. If the rate does move in the desired direction with the dollar getting stronger and the pound weaker, at the option's expiration, the buyer would forgo the option right and the seller gain for the premium paid.
3. Sell an option to close a position. For the option that has a call on the pound and put on the dollar, the buyer of the option has favored the pound over the dollar, an opposite assessment to that from the option seller. If the rate moves in the buyer's direction, the buyer can close the prior position of buying pound and selling dollar before its expiration date by selling another option that is also a call on the pound and a put on the dollar but at a different strike price. The buyer would gain from the strike price differential by canceling out the two positions. The process of closing an option this way is termed 'sell to close' and well explained by Investopedia.