FX Options Tutorial and Brokers – Learn how to Trade

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FX Options Tutorial and Brokers

The new FX Options from IQOption combine the best of both worlds – a derivative option with binary returns that trade like spot forex positions. Here we explain what an FX option is, how to trade them and which the best FX Options brokers are.

FX Options Brokers

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ESMA Compliant

These options are compliant with the ESMA regulation and available to EU traders.

Like spot FX, your entry price for the FX-Option is the price of the underlying pair at the time of your purchase.

Unlike spot FX the options come with a limited lifespan, there is an expiry, and your profits are based on a system of strike prices.

How Do FX Options Work?

This is how they work. When you pull up a chart of the FX-Option you will see a series of strikes (strike prices) to the right of the price action.

You will choose one of those strikes and the direction of the trade, whether you think prices will rise or prices will fall.

If you buy a call and price rises you can make profits after you clear a spread up to and until one of two things happens:

Expiry

The first is expiry.

If the option expires there are two possible outcomes. If the asset closes above your strike your trade is automatically closed at a profit, whatever profit is showing. If the asset closes below your strike the entire trade is a loss.

The second thing that can happen is that you decide to close the trade – yes, close the trade!

Unlike binary options the FX-Options can be closed at any time so you can lock in whatever profits or losses you are showing before the option expires.

Strike Prices

The strike prices are also important because of leverage, the further out of the money your strike price is the higher the return you can expect to receive.

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The catch is that there is a window or spread to overcome that is tied to the amount of money you trade.

The break-even point is an amount equal to the amount you trade.

The deeper in the money your strike the easier it is to overcome but your profits will be smaller, the further out of the money your strike the harder it is to overcome but your profits will be larger.

Profit Bar

There is a tool to the side of the chart that shows how much profit or loss you can expect from a position at the time of expiry.

The gauge is a handy guide but can be confusing because it moves up and down with the value of your open positions and can show losses immediately after you purchase an option.

The thing to remember is that the gauge will change, and that if your option is above the strike price you will not lose the entire trade.

Limited Losses

Because you are buying contracts and not opening a spot position your losses will always be limited to the amount of money you trade.

This means that there are no short positions, if you are bullish you buy a call and if you are bearish you buy a put.

Expiry on these positions is usually about one hour but, again, that doesn’t really matter because you can buy or sell these options at any time, and even buy and sell the same option over and over again if it keeps making money.

Greeks

With the option having an expiry time, time decay becomes a factor for the pricing.

This can also be seen from the payout gauge. As an option gets nearer to expiry, the potential for price moves of a certain magnitude change. This can result in some very tempting payout percentages appearing as an option comes to close the closing.

Volatility and time decay are both in play when you trade FX Options.

IQ Option

Right now, these options are only available at IQ Option. The range of markets is limited to the 5 major forex pairs, and the expiries are set at 1 hour intervals.

As the popularity of the product grows, expect further markets to be added, and more expiry options – particularly end of day.

Forex Options Basics

Understanding Options

Options are usually associated with the stock market, but the foreign exchange market also uses these derivatives in trading. It gives traders the opportunity to make money at a risk he has set for himself. To understand this concept better, let us use the example of purchasing a car.

If you hold a contract that requires you can buy a certain car on May 1st at a price of $1,500, you have an option to buy the car. This option ensures that if the value of the car increases at the predetermined time of purchase (in this case on May 1st), then you will profit from it because you can sell the car to another person for more than the amount you originally paid for.

On the other hand, if the value of the car decreases from the original amount, it wouldn’t be beneficial to buy that car. The option gives you the right to buy, in this case, the car but not the responsibility to pay for it if you don’t want to. This significantly lessens the risks to the trader. There are basically two types of options available to retail traders. These include the traditional call/put option and the single payment option trading (SPOT) trading.

Types of Forex Options

Traditional Option

The traditional call/put option works very much like the stock option. It gives the buyer the right (but not the obligation) to buy from the option seller at a specified time and price. For example, a trader can purchase the option to buy four lots of EUR/USD at 1.4000 for a certain month (this contract is called a EUR call/USD put). Remember that in the options market, you buy a call and a put at the same time. If the price of the EUR/USD goes below 1.4000, then the buyer loses the premium. But if the EUR/USD increases to 1.6000, then the buyer can use the option and gain the four lots for the agreed upon amount and sell it at a profit.

The Forex option are traded over-the counter. Because of this, Forex traders can easily choose the price and date of their preferred option. They will receive a quote regarding the premium they need to pay in order to get the option. There are two kinds of traditional options available today:

American Style Option
Can be used at any point until the expiration date

European Style Option
Can only be used at the point of expiration

Probably the main advantage of traditional call/put option over its counterpart is the fact that it requires lower premium. In addition, because the American-style option allows it to be traded even before expiration, forex traders gain more flexibility. On the downside, traditional options are requires more work to set and execute compared to SPOT options.

Single Payment Options Trading (SPOT)

SPOT options have almost the same concept as traditional options. The main difference is that the forex trader will first give a scenario (UER/USD will break 1.4000 in 2 weeks), gets a premium, and then receive cash if his scenario occurs. SPOT trading converts the option to cash automatically if your trade is successful. This type of option is very easy to trade because it only requires you to enter a scenario and then wait for the results.

Essentially, if your scenario plays out, you receive cash. But if it is incorrect, you will shoulder the loss of the premium. Another advantage of the SPOT option is it allows a wide variety of choices for the trader. He can choose the exact scenario that he thinks will play out. The main downside of the SPOT premium is that it is higher. In general, it costs significantly more than its counterpart.

Benefits and Downsides of SPOT Options

Benefits:
There are a lot of reasons why SPOT options appeal to a lot of investors and forex traders. Among its many benefits include:

  • Financial risks is limited to the premium (the payment to buy the option)
  • Infinite profit potential
  • The trader sets the price and the date
  • Requires less money up-front compared to the spot Forex position
  • The option can hedge against cash positions and limit risks
  • Options give the opportunity to trade on predictions about future market movements without the risk of losing a lot of capital
  • SPOT options provide a lot of choices including standard options, one-touch SPOT, No-touch SPOT, Digital SPOT, Double one-touch SPOT, and Double no-touch SPOT.

Downsides:
But if options have all these benefits, why isn’t everyone into this type of forex trading? It is important to recognize that it does have its downsides as well.

  • Premium varies depending on the date of the option and strike price. Because of this, the risk/reward ratio fluctuates as well
  • SPOT options are not allowed to be traded. Once you buy it, you can’t sell it
  • It is difficult to predict when and at what price the market will move

What Determines the Option Price?

As was mentioned earlier, the premium price can vary because of several factors. This is why the risk/reward ratio of forex options trading varies. Some of the factors that determine the price are:

Intrinsic Value
This is the current price of the option if it was used. The position of this price against the strike price can be described in three ways such as “in the money” (when the strike price is higher than the current value), “out of money” (the strike price is lower than the current value), and “at the money” (the strike price and the current value are at the same level).

Time Value
This reflects the uncertainty of market movements over time. In general, the longer the time period of the option, the higher the price you have to pay.

Interest Rate Differential
A change in the interest rates has an impact on the relationship between the strike price and the current market value. This differential is often included in the premium as part of the time value.

Volatility
High volatility increases the probability that the market price will hit the strike price in a certain timeframe. Volatility is often included as part of the time value. Usually, volatile currencies require higher premiums.

4x Options Conclusion

Options offer another opportunity for traders to make a profit with lower risks involved. Forex options, in particular, are prevalent during periods of political uncertainty, important economic developments, and significant volatility. It is up to the trader whether he will take advantage of the opportunity presented by forex options or not.

FX Options Tutorial

Conventional foreign currency trades (also called forex or FX) involves buying currencies using very low margin requirements. This offers large potential profits, but means each trade carries very high risk. Traders purchase FX options to reduce risks for other market positions or as stand-alone trades in which risk is limited to the premium paid for the option. FX options confer the right to buy one currency with another at a stated price for a specific period of time. Since you buy the first currency by selling a second currency, FX options are always simultaneously buy (call) and sell (put) options.

Study the workings of the foreign exchange market before you risk your money. Learn how major economic factors like inflation, trade deficits, and monetary policy affect currency rates. You must also gain an understanding of the “technicals,” the short term trading patterns that are essential clues for successful FX trading. It’s a good idea to open a practice forex trading account. Many forex brokers offer these accounts free of charge. You use real trading software and market information to learn FX trading “hands-on” without risking real money.

Open an account with an authorized forex broker. In the United States, forex brokers are primarily authorized by the National Futures Association and must be in compliance with their business and ethical standards. Make sure the broker you choose offers FX options (not all do). Consider opening a “mini” account that allows you to trade small amounts of currency to start. Regular accounts generally require initial deposits of around $2,000. Mini forex accounts may be opened for $100 or even less.

Choose the type of FX option you want. Traditional options allow you to buy one currency of a pair with the other currency of the pair at a guaranteed exchange rate called the strike price until the date the option expires. If the currency exchange rate moves in your favor, you can exercise the option and then sell the currency on the market at a profit. Single payment options trading (SPOT) options work differently. When you buy a SPOT option you propose a scenario. For example, you might predict that euros will move from $1.25 to $1.30 per euro within 2 weeks. If your prediction pans out, you automatically receive a payoff.

Enter the currency you want to “go long” on (that is, the one you want the right to purchase) and the second currency (on which you by definition must “go short”) of the pair into your trading software to purchase a traditional FX option. Ten enter the strike price and expiration date you want. The system will provide you with a premium quote (the price of the proposed option). If it’s satisfactory all you have to do is accept the offered premium price.

Monitor currency rate changes that affect your traditional FX options. You will want to exercise the option at a profit if the market moves your way. Unlike a SPOT option, a traditional FX option does not pay off automatically. You have to instruct the forex broker to exercise the option.

Purchase a SPOT option by selecting any of the types offered by your forex broker. A glossary of “exotic” or SPOT options can be found at ForexDirectory.com (see Resources below). Enter the specifics of the currencies and rate scenario you propose and get a premium quote. If you accept the trade at the quoted premium, the rest is automatic. If you prove to be correct the profit will be deposited to your forex account.

The bulk of forex trading volume is over-the-counter via the Internet. However, some FX options are traded on markets like the Chicago Mercantile Exchange. If you want to trade these exchange-listed options, you will need to open an options trading account with a conventional full service or discount brokerage firm that handles these securities

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