Generally, traders associate options with traditional stocks. However, these derivatives can also be traded on the forex market. Options help traders to earn higher profits while limiting their risks. The two main type of forex options are the Call/Put options and SPOT (Single Payment Options Trading). Whereas the latter provides more flexibility, the former works much like traditional stock options. Read on to find out more about forex options.
Types of Forex Options – Traditional Options
Options traditionally allow the buyer the right to buy an asset from the seller at a preset price and time. However, the buyer is not obliged to make the purchase. As an example, if a trader buys an option of EUR/USD at 1.3000 with an expiration period of 1 month, this trade is referred to as a EUR call/USD Put. When a Call is purchased by a trader, a Put is simultaneously purchased. If the price of EUR/USD ends up less than 1.3000, the trader loses the premium. However, if the values shoots up to say 1.4000, the buyer can gain two lots for 1.3000 and these lots can be sold for a profit.
Forex options are traded over the counter and the trader has the liberty to choose the price and choose the date for the validity of the option. They then receive a quote which states the premium to be paid to get the option. Traditional options are of two types: American and European style options. Whereas in the former, the option can be exercised at any point in time up till the expiration period, in the latter, the option can be exercised only at the expiration of the specified time. Traditional options have lower premiums than SPOT and dealing with American style options allow more flexibility. However, SPOT options are easier to both set and execute than the traditional options.
In the case of SPOT, the trader can specify a price and time for a forex pair, say EUR/USD will break 1.3000 in 10 days. On this basis, the trader obtains a cost quote and receives a payout in case the option ends successfully. If the trade is unsuccessful, the trader loses the premium. Forex options brokers offer the trader many scenarios from which the most probable one can be chosen. The premiums for Spot options are higher than that for traditional forex options.
Why Are Forex Options Popular
Forex options are becoming more popular among traders for the following reasons:
- The risk of loss is limited to the premium paid.
- Profits that can be made are unlimited.
- The trader can set both the price and the expiration date.
- Traders can predict direction of price movement with less capital investment.
- Forex options brokers allow many variants for SPOT options. Some of them are: One-touch, No-touch, Digital, Standard, Double One-touch and DoubleNo-touch SPOT options.
For a trader it is also important to note that once a SPOT option is purchased, it is not possible to trade it. The risk/reward ratio varies according to the premium. The premium is dependent on the date and strike price of the option.
Option Prices – Factors
The factors that determine the price of the options are as follows:
The intrinsic value of the option or the price of the option if it were exercised at that point in time is described in one of the three methods:
If the strike price is higher than the current market price, it is said to be ‘in the money’. If the strike price is lower than the current market price, it is referred to as ‘out of the money’. If the current market price equals the strike price, it is said to be ‘at the money’.
Time value is a factor that is indicative of the uncertainty of the price over the period of the options contract. If the expiration time is farther away, the premium is high because of the greater time value. A currency with higher volatility has more likelihood of hitting the target price within the specified expiration period. Usually this is factored into the time value. Options premiums are typically higher for volatile currencies. Interest rate is another variable that has an effect on both the strike price and current price of the option. This is also factored into the time value.
Options are used by traders to make profits or to hedge against risks. Options for profits are used by traders when important reports or events are expected in the market. At these times there is an increase of both the risk and the spread. These are times when options bring in more earnings than the cash in the market.
Options are used liberally by traders to hedge against existing positions in the market to reduce the risk. In some instances, traders use options along with stop-loss points. When both are used together there is a potential for high profits if the prices move in the opposite direction of your position.
What is Forex Binary Options
Forex binary options are a popular form of trading that conventional forex traders are seen to prefer. The reasons for its popularity are many. This method is relatively stress-free and requires less investment. The loss is predetermined and the trade automatically expires on the date that is preset.
The best forex binary options brokers offer different expiry times for options contracts ranging from 1-minute, 15-minutes and 30-minutes, to even 1-hour. Traders only have to predict the direction of the price movement of the chosen currencies at the expiration times of the contract. If the trade ends in the money, the trader can make even up to 85% of the trade amount. If the trade ends out of the money, some of the best forex binary options brokers even pay back up to 10% of the trade amount.
Wrapping up, it is a good idea for the novice trader to choose a manual system that is specially designed for trading in forex binary options as well. Such a system can help the trader to set up a Meta Trader platform to generate the trades.