What is Forex Option Trading? Know about Trading Strategies and how its Different from Traditional Trading Part 1
Without a long introduction, let’s directly get into currency option trading. A currency option is like a contract that gives the right of buying and selling certain currency to the buyers at a definite exchange rate on or before a certain date. In order to get this right, a premium is paid to the seller. The amount of this premium depends on the number of options. Moreover, the premium is different if the option is bought on an exchange or over the counter market. Individuals, financial institutions, and corporations can easily avoid adverse movements of currencies through currency option trading.
Types of Currency Options
There are two main types of currency options: call and put. Investors can hedge against the risk in foreign currencies by either purchasing a currency put or currency call. Let’s discuss each one of them in a little more detail.
This type of currency option provides the right to the buyer but not the obligation to purchase an asset at a defined price. This price is also known as the strike price. The option purchased at the strike price is valid for a certain period of time. The option becomes worthless if the stock fails to meet the strike price before the expiration date. Call options are purchased by the investors when there is an expectation that the price of an underlying security will rise in the future. Similarly, the option is sold when there is an expectation that the price will fall. The process of selling the option is known as ‘writing’ an option.
This type of currency option offers the buyer the right to sell an asset at the strike price. In this case, the seller of put option, also known as the writer, is obligated to buy the stock at the specified price or the strike price. The best benefit of put option is that it can be exercised at any time before the expiry date of the option. In most cases, investors buy the put options when there is a speculation that the share price of an underlying stock will fall and sell if they think otherwise.
Basics of Options
The pricing of options is set based on a number of components. The strike price, although is the rate at which the owner of the option is able to buy a currency if the investor is long a call. However, if the investor is long a put, the option can be sold. At the maturity date of the option, also known as the expiry date, the strike price is compared to the spot price or the current market price of the option. Based on the type of the option, the relation to the strike, and where the spot rate is trading, the option is either exercised or it becomes worthless at the expiry date. The currency option can also be settled for money if the option expires in the money. However, if the currency option expires out of money, it becomes worthless and no value can be generated through it in any case whatsoever.