Options are available for trading in almost every type of investment that trades in a market. Most investors are familiar with stock or equity options, however, there are options available to the retail forex currency trader as well.
Currency Option Trading
There are two types of options primarily available to retail forex traders for currency option trading.
Call / Put Options
The first is the traditional call or put option. The call 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 give investors a right to buy or sell, but there is no obligation. If the current exchange rate puts the options out of the money, then the options will expire worthlessly.
Single Payment Options Trading (SPOT)
Alternatively, the other type of option available to retail forex traders for currency option trading is the single payment options trading (SPOT) option. 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 inputting the desired scenario (ex. "I think EUR/USD will have an exchange rate above 1.5205, 15 days from now,") and a premium will be quoted. If the buyer purchases this option, then the SPOT will automatically pay out should the scenario occur. Essentially, the option is automatically converted to cash.
Using Exotic Options
Options are used by forex currency traders to make a profit or protect against a loss. It is also important to note that there is a wide variety of exotic options that can be used by professional forex traders, but most of these contracts are thinly traded because they are only offered over the counter. Because options contracts implement leverage, traders are able to profit from much smaller moves when using an options contract than in a traditional retail forex trade.
When combining traditional positions with a forex option, hedging strategies can be used to minimize the risk of loss. Options strategies such as straddles, strangles and spreads are popular methods for limiting the potential of loss in a currency trade.
How to Trade Forex Options Online
Not all retail forex brokers provide the opportunity for option trading within your accounts. Retail forex traders should be sure to research the broker they intend on using to determine whether everything that will be required is available. For forex traders who intend to trade forex options online – for either profit or risk management – having a broker that allows you to trade options alongside traditional positions is valuable. Alternatively, traders can open a separate account and buy options through a different broker.
Because of the risk of loss when writing options, most retail forex brokers do not allow traders to sell options contracts without high levels of capital for protection.