The (Foreign Exchange) Forex Trading Market Explained.
 

 

Currency Option Marketplace

How traders use a currency option in FOREX currency trading

A currency option is a contract that gives the holder the right, but not the obligation to buy or sell a specified currency during a specific time period.  It can be used to hedge a FOREX transaction and are a favoured method of reducing risk in companies that trade goods overseas.

There are two basic types of option: Call options and Put options.  A call option gives the holder the right to buy a currency while a put option gives the holder the right to sell. 

The worth of an option at expiry is equal to the value realised by the holder in exercising the option.  If the holder gains nothing, the option is worth nothing.  The value at any other time of the contract duration is the 'intrinsic value' – the value that can be realized if the holder exercises his option.

Intrinsic value is linked to the 'strike price' – the value specified by the option contract.  A call option has intrinsic value if the spot (current) price is above the strike price.  A put option has intrinsic value if the spot price is below the strike price.

If the option contract has intrinsic value it is said to be 'in the money', otherwise it is 'out of the money' or 'at the money' (at par).  Options would only be exercised if they are in the money.

Options are priced according to complex formulas that take into consideration both the spot value and time value.  Time value is calculated according to expected market conditions including volatility and the difference in interest rates between the two currencies.  Options must be priced low enough to attract potential buyers and high enough to attract potential writers (the sellers or guarantors of the option).

Currency options are used in FOREX to minimize risk against unexpected moves in the market.  If you buy an option your losses are limited to the cost of the option.  Those who sell options are more vulnerable.  They gain the premium but they are exposed to unlimited loss if the market moves against them.

As a hedging tool, there are many different types of options available.  They are often used by companies that trade overseas to minimize the potential for loss due to fluctuations in the foreign exchange market.

FOREX trades have a special type of option available known as a Digital Option.  This option pays a specified amount at expiration if the criteria are met, otherwise it pays nothing.

FOREX traders who wish to use a digital option first decide which direction the market is moving.  They then decide on a payoff amount if the market moves as expected within a certain time frame.  With this information the cost of the option is calculated. 
  
For example:

The price of the euro is currently trading at about 1.2400 and you expect it to rise to 1.2800 within 3 months.  You decide to buy a put digital option with a payoff of $5000.  The cost of the option is $800.

If at the end of the 3 months the euro is more than 1.2800 you get $5000.  If the price is less, you lose $800.

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Introduction to Online Forex Trading
Current Forex Currency Rates
Forex Trading
How to Get Started In FOREX Trading
FOREX versus Futures Market
FOREX versus Stocks
FOREX Trading Philosophy
FOREX Tools
Fundamental Analysis In Forex Trading
Forex Technical Analysis - Part 1
Forex Technical Analysis - Part 2
FOREX Trading Strategies
Trading Currencies on Margin
Currency Option Marketplace
FOREX Signals
How to Read FOREX Quotes
Calculating FOREX Profits and Losses
Risks of FOREX Trading
FOREX Training
FOREX Trading Software
FOREX Brokers
FOREX Glossary
Forex Updates and Training
Crash Course in Forex Education
How to Recognize Patterns in Forex Trading Markets
Defining Exotic Currencies and Their Impact on Forex Markets
Defining Trading Trend and Ranges in Forex Trading
Mind Games – The Psychology of Forex Market Trading
Crossing Currency - What’s This Mean to Forex Traders
Money Management Basics for Forex Traders
Choosing Your Forex Broker
Expensive Beginner Forex Trader Mistakes
The Elliott Wave Theory for Forex Markets
Failsafe Facts to Guarantee Failure in Forex Trading
Five No Nonsense Strategies in Forex Trading
Global Expansion and It’s Reaches within the Forex Market
Hedging in the Forex Market
The Important Ways to Keep From Losing in the Forex Markets
An Overview of the Euro’s Performance in the Forex Markets
Six Trading Tips for the Forex Newbie
The Lowdown on Day Trading
Interpreting How Interest Rates Drive the Foreign Exchange Markets
The Basics of the Bollinger Band Technical Indicator in Forex Markets
Relative Strength Analysis in Forex Trading
The Basics on Understanding Forex Options
Forex Charts – What Are They and How Do You Read Them
Interpreting the Future of the Oil Marketplace and How It Affects Forex Trading
Top Five Economic Indicators that Drive Forex Trading
Rules for Trading in Forex Markets
How Does the Japanese Yen Stack Up Against the US Dollar in Forex Markets
Pivot Points in Forex
The Ins and Outs of Trying Out a Forex Demo Account
The Top Currencies to Watch in the Forex Trading Game
Defining Moments Regarding Trading Trends and Ranges with Forex
Top Ten Basic Terms in Forex Trading and Their Definitions
Forex Folklore Investment Myths in the Market
Five Economic Driving Forces that Influence Forex Trading
Day Trading All You Wish You Did Not Have to Know
Time line for Daily Forex Trading When are the Optimum Moments
Forex Relative Strength Analysis
How Forex Quotes Can Influence your Trading Tactics
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