Posted by forex at 5:56 AM
Read our previous post
1. Learn the differences between currency options and other types of options. Foreign currency trades in pairs, one currency against another. When one currency rises in value against the second, the second necessarily falls in value relative to the first. As a result, a currency option is always a 'call' and a 'put' at the same time. For example, if you buy an option for the euro and U.S. dollar with the option to buy euros at an exchange rate of $1.4000 per euro, this would be listed as EUR (call)/USD (put).
2. Open a Forex trading account online with an authorized currency dealer. Be sure the dealer you choose allows currency options, as not all brokers do. Foreign currency trading is a self-regulating securities market, and in the United States, the Securities and Exchange Commission recommends you choose a broker authorized by the National Futures Association. Virtually all Forex trading is done online using software 'trading platforms.' Most good brokers provide the software if you don't have your own.
3. Choose a traditional Forex option by first logging in to your trading account online and checking the current exchange rate for the currency pair you are interested in. Unlike other options, you may choose the strike price at which you will have the right to exercise the option. You also get to pick the expiry (expiration date) of the option contract. Enter this information along with how many lots of currency and whether you are going long or short on the base currency of the currency pair (this is always the first currency listed). For example, if you think the euro will strengthen against the dollar in the next 30 days and the current exchange rate is 1.3400 dollars per euro, you would go long on the euro by entering EUR (call)/USD (put) = 1.3400 with an expiry of 30 days from now.
4. Query the broker to find the cost of the option before you actually execute the transaction. You will get a response telling you the broker's premium (fee) in pips. A pip is the smallest amount the currency pair rate can change by. For the EUR/USD pair, a pip is $0.0001 (1/100 cent), which, for a standard lot of $100,000, works out to $10. Continuing the example from Step 3, let's say the broker quotes a premium of 25 pips ($250) and you decide that's too much. Change the strike price to 1.3500 and try again. With this new strike price, the euro will have to go up some before you make any money, but the broker's risk is lower, and the quote you get is 10 pips (a premium of $100), so you execute the transaction.
5. Monitor the exchange rate. If the market moves in your favor over the next month so that you are 'in the money,' you may exercise the option, making a profit. However, if you've guessed wrong (in our example, the U.S. dollar gets stronger), you will lose the money you paid for the option. However, that's the limit of your risk. By contrast, if you take a position holding the currency itself and the market goes against you, you could lose much more. For instance, a 3 cent (300 pip) change on one lot of the EUR/USD pair works out to a total loss of $3,000. Your potential profit isn't limited, however. If there's a 3 cent gain over the strike price, you make the entire $3,000 as profit, minus the premium.
6. Buy SPOT options to take advantage of market trends. Single Payment Option Trades work differently than other option trades. Using your trading software, you select a target strike price you think a currency pair will reach in the coming weeks and an expiry date. You then pay a premium to your Forex broker to purchase the SPOT option. If the currency rate reaches your selected strike price, the transaction will automatically close out, and your profit is added to your account balance. If you've guessed wrong, the expiry date will come and go and you get nothing.