Trading Forex with Options
Over the last 15 years that I have been trading, I have made efforts to fully understand multiple asset classes as I believe this is the best way for anyone to ensure maximum diversity, minimum risk and, of course, better profits across their investment portfolio. While I have always been very active in FX trading, it has always been options trading which sparked the most interest for me due to its multiple layers of complexity and strategy. With so many contracts, expiry dates and a whole host of strategies ranging from iron condors and strangles to vertical spreads, options are truly unique and allow us to make money from markets moving up, down and sideways, too. They can be used for position protection and stop losses as well, with the ability to also take in high probability profits from premiums when the odds are stacked in our favor. The question is, how can they be used in Forex?
When you trade an options contract, you never actually own the stock, currency or underlying asset but instead you are buying the right to own the underlying asset at a later time and date. If the underlying asset on which the option is held goes up in value and the trader has a contract saying that they can own it at a much lower price, then this would provide a great profit for the owner of the option contract. The only thing that the trader has to do first, is to pay a premium to actually own the option contract in the first place. Simplified, it is much like paying a premium for car insurance. When the term of the insurance runs out, you have to pay another premium for more coverage, but if you have an accident and need to make a claim on your insurance policy, then the contract really becomes worth something of value to you. Options are no different.
To make the most of options though, I would suggest a solid understanding of market direction analysis and risk management before anything else. If you are already working with a consistent trade plan which allows you to find solid objective buying and selling opportunities, along with well written rules for protecting your trading capital in the event that you are wrong, then options are pretty much like trading anything else.
When it comes down to the actual trading itself, in options we only have two specific forms of contracts, which are as follows:
The Call Option: Which gives the buyer the right to buy an underlying asset at a pre-agreed price and the seller the obligation to sell an underlying asset at a pre-agreed price, all within a limited period of time.
The Put Option: Which gives the buyer the right to sell an underlying asset at a pre-agreed price and the Seller the obligation to buy an underlying asset at a pre-agreed price, all within a limited period of time.
The big choice comes in options when the trader has to decide when they wish to be a buyer or a seller of the call or the put option. Call options make money when the underlying goes up in value, whereas Put options make money when the underlying goes down in value. There are other aspects like time and volatility which also have an impact on the premiums of options as well, but we will touch on that in a while.
For now, let’s look at when an option could be used. Take the below chart of EURUSD: