JAN 10: The Basics on Understanding Forex Options

by David Jenyns on January 10, 2007

There are many different options a trader can use when trading on the foreign currency exchange or Forex market. Any trader can find which option works best for their personal needs when they look at all of the different options that are available. Using options when trading on the Forex, offers many benefits to the trader.

When trading on the Forex, there are two major types of options available to traders. The most common option is call the call/put option, which works similar to stock options and the other called single payment option trading, or SPOT. This option gives traders more flexibility when it is done properly.

With the two types of options that are usually used on the Forex, the traditional option allows the buyer the right but not the obligation to purchase something from the option seller. This means that the buyer is not locked into a trade or purchase at any set time or prince. If trader purchases a Forex option to buy two lots of euros to dollars at a certain price, this is called a call/put trade. If the pair is below a set amount the trade does not turn a profit and the buyer will lose the premium. If however, the pair rises, then the buyer has the option, or the choice, to gain two lots at the initial price. Then the pair can be sold for a profit to another buyer.

Within the traditional Forex options, there are two sub-categories. These include the American-style traditional option, which allows the trader or broker the option of buying or selling at any point until the expiration of the pair. The other one is the European-style option. This Forex option allows the buyer to make a purchase only at the time of the expiration.

There are several advantages for using the traditional options when trading on the Forex. One major benefit is that traditional options have lower premiums that the SPOT options. The American-style option is also good for traders because it allows for more flexibility because the options can be bought and sold before the expiration. One disadvantage of the traditional Forex option, though, is that these options can be harder to set, maintain and execute that SPOT Forex options.

Single payment options trading, or SPOT for short are easy to trade and are often the most popular among traders. When a trader inputs the scenario of their ideal trade and obtains a premium quote, they receive a pay out, or makes a profit, if that scenario is successful. The SPOT option converts the option to cash and gives the trader a payout on the transaction.

Using the SPOT option when trading on the foreign currency exchange is really just a matter of knowing and understanding which scenarios will be profitable, setting those parameters and letting it play out. If the trader is correct and the scenario does in fact take place, then the trader has made a profit. If not, they experience a loss. The loss is the traderís premium. There are many different scenarios that can take place using the SPOT option and for traders this is usually seen as a big advantage over the traditional Forex option. However, one disadvantage is that usually the SPOT options have much larger premiums and will cost more than the raditional options.

Many Forex brokers and traders like to use options when trading on the foreign currency exchanges. The options have an appeal that most traders like. When using either the traditional options or SPOT options, the risk is limited to the option premium, which is the amount that is paid to purchase the option. Also, there is the potential to earn an unlimited amount of profits when using these types of options. With these options, less money is needed to pay up front. Additionally, the options are popular among traders because they get to set the price and expiration date. These are not pre-set or pre-defined like some options. Options are also appealing to many traders because they can be use to hedge to limit the amount of risks. Many brokers and traders enjoy the flexibility that Forex options offer. When learning to buy, sell or trade on the Forex, it is important to learn and understand these types of options before setting up any kind of account.

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