How Does One Profit from Currency Option Trading?
November 14th, 2009
Being an active trader in the currency markets can be a high risk venture. To participate in the market many people opt for currency option trading instead. Moves up and down in a currency price can be played using puts and calls. If a trader buys a put he/she believes the price of the currency will soon decline. If they are right, they can buy the currency at a low price and put(sell) it at the stated strike price. If they think prices will move higher they buy a call. If they are correct, they can call(buy) the currency at the strike price and immediately sell it at a higher price in the market. Options have a set life span. After this time passes they expire.
One type of option contract used by speculators and hedgers is the traditional option. This contract requires the trader to set a strike price and an expiration date. These two factors along with the currency volatility level are used to determine the premium the broker charges for the option. If the premium is agreed upon the transaction is completed. If the currency pair being traded is the USD/CHF and the trader thinks the Swiss franc will move up against the dollar he/she will purchase a put on the dollar. If the prediction is correct in the set time frame, the trader will purchase the dollar and put(sell) it at the strike price realizing a profit.
The SPOT contract is another type used in currency option trading. It is a “single payment option trade.” This means that if for example you feel that the euro will advance against the dollar and you buy calls on it, if you are right you do not need to actually purchase the currenct=y and sell in the market to make a profit. The profit from the option is automatically deposited in your trading account. Brokers charge a higher premium for trading this type of contract, however for speculators is the easiest way to trade.
The amount the broker charges for the option is the premium level. Several things will affect the premium level. The strike price is one of them. The closer it is to the market price the higher the premium will be. The more time until expiration the higher the premium. Highly volatile currencies will likely have higher option premiums.
There are different reasons for engaging in currency option trading. One reason is to trade strictly to make money on the moves up and down in the currency prices. Speculators trade purely for profits.
Hedging is a common use of currency option trading. People or corporations doing business with companies in foreign countries can purchase options to protect themselves from loses they may incur on in-process business. If prices fluctuate on currencies to much before transactions are completed they may lose the profits generated by them.
A riskier strategy of trading currency options is selling options short with the intention of covering them when the price moves in the correct direction. Since loses are not limited in this style of trading. brokers typically require large cash deposits to secure these trades.
As we have discussed, currency option trading can be a very profitable venture if you trade correctly. Premiums on options are typically smaller than deposits for the actual currency so profits can be large. One of the primary benefits is that with options you can limit your loses.
Before you proceed with any currency option trading be SURE to read up on 4x currency trading!