Usage of Options in FX Trading

Usage of Options in FX Trading

The usage of option when trading foreign exchange has always been a popular among foreign exhange traders. There are two basic types of options: calls and puts.

Call options

A Call option provides the buyer with the right, but not the obligation, to purchase the underlying asset at a specified price, called the strike or exercise price, at any time up to and including the expiration date.

Put options

Provides the buyer with the right, but not the obligation, to sell the underlying asset at the strike price at any time prior to expiration. Note, therefore, that buying a put is a bearish trade, while selling a put is a bullish trade.

The price of an option is called the premium and it is quoted in either dollars per unit or points.

As a specific example of an option, a trader who buys an August 75 Swiss Franc call at a premium of 56 points pays $700 for the option (.56¢ x 125,000 francs).

The option, in turn, conveys the right to buy 125,000 Swiss Francs at a price of 75 (75¢ on the U.S. Dollar no matter how high the price of the Franc may rise) between the time of the purchase and the August expiration day.

The buyer of a call seeks to profit from an anticipated price rise by locking in a specific purchase price (the strike price). His maximum possible loss will be equal to the dollar amount of the premium paid for the option plus commissions and fees.

This maximum loss would occur on an option held until expiration if the strike price were above the prevailing market price, also known as out-of-the-money. For example, if upon the expiration of the


Option Dollar value Dollar value premium x per point = of the (in points) option premium

Case 1. One Option on the Japanese Yen:

40 pts. $ 12.50 per $500.00 (option x point = (value of the option premium)

Case 2. One Option on the British Pound:

90 pts. $ 6.25 per $562.50 (option x point = (value of the premium) August option, the Japanese Yen were trading at 80, a call with a strike price of 80.5 or higher would be worthless since Japanese Yen could be purchased more cheaply at the existing market price.

If at expiration, the market price of the Yen were trading above the strike price, then the option would have intrinsic value and hence would be exercised or offset to reap the value of an in-the-money option.

For example, if the Yen were trading at 90, and the option’s strike price were 82, then the owner of the option could exercise his right to buy the Yen at 82 an instantly sell the Yen at the market price of 90.

(Note: if the difference between the market price and the strike price were less than the premium paid for the option, the net result of the trade would still be a loss.)

In order for the call buyer to realize a net profit, the offsetting price must be greater than the purchase price of the option (premium plus commissions and fees). Since all options values are determined by a market value based upon time, volatility and intrinsic value, an option may be sold at a profit even without the asset price above the strike price.

The higher the asset’s price, the greater the resulting profit. Of course, if the price of the asset reaches the desired objective, or the call buyer changes his market opinion, he could sell his call prior to expiration regardless of the profit or loss on the trade.

Put Options

The buyer of a put seeks to profit from an anticipated price decline by locking in a specific selling price (the strike price). Similar to the call buyer, his maximum possible loss is limited to the dollar amount of the premium paid for the option plus commissions and fees.

In the case of a put held until expiration, the trade would show a net profit if the strike price exceeded the price of the underlying crypto asset by an amount greater than the premium of the put at purchase (after adjusting for commission cost.)

Options Selling or Writing

Whereas the buyer of a call or put has limited risk and unlimited potential gain, the reverse is true for the seller.

The option seller (also known as a writer or granter) receives the dollar value of the premium in return for undertaking the obligation to assume an opposite position at the strike price if an option is exercised.

For example, if a call is exercised, the seller must assume a short position in the asset at the strike price (since by exercising the call, the buyer assumes a long position at that price).

Upon exercise, the option writer will establish these opposite market position at the strike price. After exercise, the call buyer and seller can either maintain or liquidate their respective market positions.

The seller of a call seeks to profit from an anticipated sideways to modestly declining market. In such a situation, the premium earned by selling a call will provide the most attractive trading.

However, it should be noted that even in this case, the call buyer could have recouped part of the premium if he had sold the option prior to expiration. Bitcoin can also be taken into consideration. This is true since the option will maintain some value (i.e., premium greater than zero) as long as there is some possibility of the asset’s price rising above the strike price prior to the expiration of the option.

Even if the call is held until the expiration date, it will usually still be easier to offset the position in the options market rather than exercising the call. Technically speaking, the gains on a put would be limited, since prices cannot fall below zero; therefore, it is not technically correct to speak of the maximum possible gain on a long put position as being unlimited. However, if the trader expected a large price decline, he would usually be better off buying a put – trades with open-ended profit potential. In a similar fashion, the seller of a put seeks to profit from an anticipated sideways to modestly rising market.

Probability – Buying V Selling

Some novices have trouble understanding why a trader would not always prefer the buy side of an option (call or put, depending on his market opinion), since such a trade has unlimited profit potential and limited risk. Such confusion reflects the failure to take probability into account.

Although the options seller’s theoretical risk is unlimited, the price levels that have the greatest probability of occurrence (i.e., prices in the vicinity of the market price at the time the option trade occurs) would result in a net gain to the option seller.

Roughly speaking, the option buyer accepts a large probability of a small loss in return for a small probability of a large gain, whereas the option seller accepts a small probability of a large loss in exchange for a large probability of a small gain.

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