Forex Option & Currency Trading Options

DEFINITION of 'Forex Option & Currency Trading Options'

A security that allows currency traders to realize gains without having to purchase the underlying currency pair. By incorporating leverage, forex options magnify returns and provide a set downside risk. Alternatively, currency trading options can be held alongside the underlying forex pair to lock in profits or minimize risk. In this case, limiting the upside potential is usually necessary for capping the downside as well.

Because options contracts implement leverage, traders are able to profit from much smaller moves when using an options contract than a traditional retail forex trade would allow. When combining traditional positions with a forex option, hedging strategies such as straddles, strangles and spreads can be used to minimize the risk of loss in a currency trade.

Because of the risk of loss involved in writing options, most retail forex brokers do not allow traders to sell options contracts without high levels of capital for protection.

BREAKING DOWN 'Forex Option & Currency Trading Options'

Not all retail forex brokers provide the opportunity for option trading. Retail forex traders should research prospective brokers because for traders who intend to trade forex options online, having a broker that allows you to trade options alongside traditional positions is valuable; however, traders can also open a separate account and buy options through a different broker.

There are two types of options available to retail forex traders for currency option trading: put/call options and STOP options. The call option gives the buyer the right to purchase a currency pair at a given exchange rate at some time in the future. The put option gives the buyer the right to sell a currency pair at a given exchange rate at some time in the future. Both the put and call options are a right to buy or sell, and not an obligation. If the current exchange rate puts the options out of the money, then the options will expire worthless.

Single payment options trading (SPOT) options have a higher premium cost compared to traditional options, but they are easier to set and execute. A currency trader buys a SPOT option by inputing a desired scenario (e.g. "I think EUR/USD will have an exchange rate above 1.5205 15 days from now"), and is quoted a premium. If the buyer purchases this option, the SPOT will automatically pay out if the scenario occurs. Essentially, the option is automatically converted to cash.

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