/ Use options to improve your trading

Forex options: How they work

One of the first things a beginner trader should learn is options trading. Learn the basis - and boldly buy and sell!

Forex Options

An option is an instrument, a kind of bargain. It allows you to buy and sell currency at a predetermined time. This date is called the exercise date, and the specified price is called the strike price. You do not have to actually buy the currency. The option gives you the right to do so, but you are not obliged to enter into the transaction.

The important thing to remember here is that Forex trading is essentially speculation. There are no actual physical assets in your possession. You can choose between two trading options: Forex options and spot trading.

One of the pros of options is that they reduce the risk of buying. Traders often favor them for this reason. You don't have to buy currency if you choose not to - so you can protect yourself from unfavorable trades. There is a downside - your risks are also very high.

The main aspects

If you decide to try options trading, you need to consider some subtleties:

1. Currency pairs only

Trading options is always trading currency pairs. You enter into a certain contract. You have an underlying currency that you agree to buy and a quote currency that you want to sell.

Your benefit is that if your prediction comes true, you make a profit, and if it doesn't, the option doesn't obligate you to make a trade.

2. Two types of options

You have two options to choose from at once: call options and put options. Each has its own special features.

Call option

This is a two-way stick. A call option can bring you big profits and big losses. You should buy such an option when you are sure that your base currency will definitely rise before the strike date. Let's say you have chosen the EUR/USD currency pair. If the euro rises, you have won and your profit is unlimited. If you don't exercise the option, you will only pay the agreed-upon premium.

If you change your mind and you see that the quoted currency will rise before the strike date, you can sell the option. However, if you do make a mistake and the price movement is not to your advantage, your losses will also be unlimited.

Put option

Let's say you are confident that the quoted currency will rise before the exercise date. Then you buy a put option. Now you will choose EUR/USD if you think that the dollar will rise against the euro. Otherwise, everything is exactly the same. You guessed - your profit is unlimited. If you don't guess, you will only have to pay a small premium.

You can also buy such options if the base currency will grow relative to the quoted one. However, in this case your risks are not limited either. You will suffer heavy losses if you do not guess the price movement. Handle it with care.

3. Hedging

Hedging is your insurance. The essence is that you open an additional position, which covers the risk of the existing one. Very often put options are used for this purpose. This is an effective way to protect yourself from currency depreciation.

You need to open another position with a strike price lower than the current level. If the price falls below your put option, you can profit from it. This profit will cover your losses on the open position.

4. Safe Trading

Using these two types of options is much safer than going into spot trading. You will only lose your margin - the option premium - if the movement is against you. But that's only part of the truth. In fact, the premiums can be high, the risks can be enormous, and it's not always possible to find an options market that will work around the clock. All of these things need to be taken into account as well.

How to trade

1. Understand the topic

For example, there are barrier options. They move towards each other along with the price of the underlying market, and at a very high speed. Here, you choose the level of attrition and when the price reaches this level, the options close on their own. This allows you to keep all the risks in your hands.

There are also vanilla options. These are more familiar. Here everything is simple: you get the right to buy or sell at a predetermined time at a predetermined price. However, they can be complicated. The price of such an option is affected by volatility, the time until the date of execution, the price of the base currency and not only. Choose this type of option if you already have trading experience.

2. Currency Pair

If you do decide to trade options, you need to choose a currency pair. There are quite a few of them. Among the main ones are, for example, EUR/USD and USD/JPY. There are some non-standard pairs as well. Some of them are just used less frequently, for example CAD/CHF. Others are just gaining momentum, such as USD/CNH and AUD/CNH. Besides them, there are also pairs that are called exotic: TRY/JPY and USD/MXN, for example.

Each currency pair will have its own peculiarities and each will need its own approach. Study them before making a choice.

3. Trading account

Now you need to open your trading account. To trade options, you need a vanilla or barrier account. To open one, all you need to do is pay an option premium - margin.

4. Choosing an option

If you decide to try barrier options, you need to choose between call and put options. Then you can buy or sell. You can also choose an exit level. Your position will close on its own if the market goes beyond this level.

If you choose vanilla options, it will be a little different. You have an exercise date. Before this date, the market can go above a given level or go below it. Here you take a position depending on your forecast. You can close this trade before the strike date, or you can leave it - it will simply expire.

5. Execution Price

This is a basic trading term. The strike price is the price at which the option is exercised. For this to happen, the market must rise above the strike price. Then you will make a profit. If the market is below that level, the option will lose value too.

6. Tracking

Let's say you have taken a position. Now you can track it on your platform. If the platform provides any analysis tools or indicators, so much the better. Even so, monitor the news and in general anything that may be relevant to your trade.

Conclusion

Options trading is a good choice for both beginner and pros looking for new opportunities. Beginners will find in options the opportunity to trade with less risk, but you need to remember that this type of trading has its own dangers. Evaluate them in time - and your trading will be successful.

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