Currency Options Trading For Beginners
One of the types of trading you are going to hear about when you first enter Forex is currency options trading. This type of trading is very popular with some traders and there are more than 3 billion options traded each year. However, it is also one of the types of trading that has the highest risk involved. Very few brokers will let traders sell these contracts without a lot of capital for their protection because the risk is so high. So, if you are going to get into options trading, it is important that you learn everything about it before you begin.
When talking about options trading you want to remember that we are talking about currency "pairs." So, let's first talk a look at the most used options trading called "standard" or "vanilla" options trading. You have a dollar amount on the face of one pair, a put/call, an expiration date for the option, a strike (this is what you're betting the dollar amount will be) and an exercise.
The put/call is the currency pair you will sell at the exchange rate in the future (expiration date). You "can" sell, but you aren't obligated to. The options are worthless if the put rate runs out of money. An expiration date on options trading is done in a week, a month, 3 months, 6 months, or 12 months.
When you see "European" exercise, the option can only be exercised, or sold on the date of expiration. If it is exercised, the option turns into a cash trade or SPOT and is completed at the strike price and settled on the SPOT value date.
An "American" exercise can take place at any time prior to the expiration date. These are valued differently than the European exercise using different numerical approximation methods or a binomial option-pricing model.
You will hear a lot about "Exotic option trading" also. These option have non-standard features and there are many hybrids and different types of exotic option trading choices. The exotic option used most often is the "barrier" or "knock-out" option. Both of these options have a barrier exchange rate that is called an "out-strike." The out-strike kills the option if it is breached at anytime before the expiration date of the option.
Other commonly used Exotic optionS are the Double Barrier option, Binary option, Double Barrier Range Binary option, Quantos Option (hedgers use this option a lot), the Average Rate option, and Compound options (these are options on options). There are many, many more types of Exotic Options that you will learn about as you delve deeper into options trading.
The advantages of options trading that is most talked about is their increase in leveraging power which makes them cost efficient, the lower cost for this type of option which theoretically reduced the risk, and the ability to hedge against reversals in exchange rates.
Having a clear understanding of how currency options trading works, and the actual level of risk involved will be important when you are making the decision of whether or not to do options trading. Taking classes, participating in forums that are run by successful options traders, and learning the intricacies of this type of trading will be very helpful in your entry into this arena.