Understanding Forex Options Brokers

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Forex Options Trading

What is Forex Options Trading?

Forex options are derivatives based on underlying currency pairs. Trading forex options involves a wide variety of strategies available for use in forex markets. The strategy a trader may employ depends largely on the kind of option they choose and the broker or platform through which it is offered. The characteristics of options in decentralized forex markets vary much more widely than options in the more centralized exchanges of stock and futures markets.

Key Takeaways

  • Forex options trade with no obligation to deliver a physical asset.
  • These options vary widely from one product to another depending on which entity is offering the option.
  • Forex options come in two varieties, so-called vanilla options and SPOT options.
  • SPOT options are binary in nature and pay out (or not) depending on the final condition of the option.

Understanding Forex Options Trading

Options traded in the forex marketplace differ from other markets in that they allow traders to trade without taking actual delivery of the asset. Forex options trade over-the-counter (OTC), and traders can choose prices and expiration dates which suit their hedging or profit strategy needs. Unlike futures, where the trader must fulfill the terms of the contract, options traders do not have that obligation at expiration.

Traders like to use forex options trading for several reasons. They have a limit to their downside risk and may lose only the premium they paid to buy the options, but they have unlimited upside potential. Some traders will use FX options trading to hedge open positions they may hold in the forex cash market. As opposed to a futures market, the cash market, also called the physical and spot market, has the immediate settlement of transactions involving commodities and securities. Traders also like forex options trading because it gives them a chance to trade and profit on the prediction of the market’s direction based on economic, political, or other news.

However, the premium charged on forex options trading contracts can be quite high. The premium depends on the strike price and expiration date. Also, once you buy an option contract, they cannot be re-traded or sold. Forex options trading is complex and has many moving parts making it difficult to determine their value. Risk include interest rate differentials (IRD), market volatility, the time horizon for expiration, and the current price of the currency pair.

Forex Options Trading is a strategy that gives currency traders the ability to realize some of the payoffs and excitement of trading without having to go through the process of buying a currency pair.

Primary Types of Forex Options Trading

There are two types of options primarily available to retail forex traders for currency options trading. Both kinds of trades involve short-term trades of a currency pair with a focus on the future interest rates of the pair.

  1. The traditional call or put option. With a traditional, or vanilla, options contract the trader has the right but is not obligated, to buy or sell any particular currency at the agreed upon price and execution date. The trade will still involve being long one currency and short another currency pair. In essence, the buyer will state how much they would like to buy, the price they want to buy at, and the date for expiration. A seller will then respond with a quoted premium for the trade. Traditional options may have American or European style expirations. Both the put and call options give traders a right, but there is no obligation. If the current exchange rate puts the options out of the money (OTM), then they will expire worthlessly.
  2. A single payment option trading (SPOT) product has a more flexible contract structure than the traditional options. This strategy is an all-or-nothing type of trade, and they are also known as binary or digital options. The buyer will offer a scenario, such as EUR/USD will break 1.3000 in 12 days. They will receive premium quotes representing a payout based on the probability of the event taking place. If this event takes place, the buyer gets a profit. If the situation does not occur, the buyer will lose the premium they paid. SPOT contracts require a higher premium than traditional options contracts do. Also, SPOT contracts may be written to pay out if they reach a specific point, several specific points, or if it does not reach a particular point at all. Of course, premium requirements will be higher with specialized options structures.

Not all retail forex brokers provide the opportunity for options trading, so retail forex traders should research any broker they intend on using to ensure they offer this opportunity. Due to the risk of loss associated with writing options, most retail forex brokers do not allow traders to sell options contracts without high levels of capital for protection.

Forex Option and Currency Trading Options

What are Forex Option and Currency Trading Options?

Forex options (also known as currency trading options) are securities that allow currency traders to realize gains without having to place an actual trade in the underlying currency pair. Forex options allow traders to pay a premium in exchange for the ability to profit from the moves of a currency block without holding or being held liable for that block. In this way, they can further leverage their currency trade and have the opportunity to magnify returns while limiting downside risk to the amount of premium paid.

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Key Takeaways

  • Forex options allow traders to leverage currency moves, limit risk, and create higher potential gains.
  • Option pricing favors the seller so purchase options rarely pay out more than they cost over time.
  • Two types of options are offered known as Vanilla and Exotic options.

Understanding Forex Option and Currency Trading Options

Because forex option and currency trading options contracts implement leverage, traders are able to profit from much smaller moves when using options contracts than a traditional retail forex trade would allow. When combining traditional positions with a forex option, hedging strategies such as straddles, strangles, and spreads can be used to minimize the risk of loss in a currency trade. While this sounds good, an important caveat is that option pricing is mostly fairly priced, meaning there is a slight bias in pricing towards the seller. This bias makes it unlikely that options will pay out more than they cost or lose over time.

Not all retail forex brokers provide the opportunity for option trading. Retail forex traders who intend to trade options online should research prospective brokers because having a broker that allows you to trade options alongside traditional positions is valuable. However, traders can also open a separate account and buy options through a different broker. Because of the risk of loss involved in writing options, most retail forex brokers do not allow traders to sell options contracts without high levels of capital for protection.

There are two types of options available to retail forex traders for currency option trading: standard (vanilla) put and call options and exotic options.

Vanilla Options

The call option gives the buyer the right to purchase a currency pair at a given exchange rate at some time in the future. The put option gives the buyer the right to sell a currency pair at a given exchange rate at some time in the future. Both the put and call options are a right to buy or sell, and not an obligation. If the current exchange rate puts the options out of the money, then the options will expire worthless.

Standard options are known as ‘vanilla’ (or ‘plain vanilla’) since they are fairly straightforward, standardized, and do not contain any additional bells or whistles that more complex or exotic options contain.

Exotic Options

Exotic derivatives can also include single payment options trading (SPOT). Spot options have a higher premium cost compared to traditional options, but they are easier to set and execute. A currency trader buys a SPOT option by inputting a desired scenario (e.g. “I think EUR/USD will have an exchange rate above 1.5205 15 days from now”) and is quoted a premium. If the buyer purchases this option, the SPOT will automatically pay out if the scenario occurs. Essentially, the option is automatically converted to cash.

Additional types of exotic options may attach the payoff to more than the value of the underlying instrument at maturity, including but not limited to characteristics such as at its value on specific moments in time such as an Asian option, a barrier option, a binary option, a digital option, or a lookback option.

Forex Options Brokers

So You’re Looking for Some Good Forex Options Brokers!

Forex Options Brokers give you a little more than traditional forex brokers because they also provide the ability to choose options on foreign currencies as either an alternative financial instrument to the spot market, or as a hedge for existing leveraged spot positions.

Most foreign currency brokers don’t boldly advertise their willingness to include options as part of your trading suite, firstly because they are less well known and second, because it is more marketable for them to make their commissions on the spread rather than having to charge a fixed transaction fee for the option trade itself.

Here are a list of forex options brokers we have found that are recommended by real people who are using them for options trades on currency pairs:

Saxo Bank is located in Europe but also have offices in Sydney, Tokyo, South Africa, Hong Kong, Panama, London and Singapore. They provide live streaming vanilla (Black Scholes pricing model) or binary forex options trading opportunities through their downloadable trading platform on twelve major currency pairs. They also offer leveraged spot forex trades and forex forward contracts, which means you can them in combination with vanilla options to offset your positions, or use the differences in delta and strategies such as the short straddle to your advantage.

Saxo Markets (as they are also called) claim to be able to provide larger strike price ranges together with longer expiration dates than other brokers. They don’t charge commissions on the trades but build it into the option spread. For example, the EURUSD might be trading around 1.3630 but the ATM call options will be at 1.3650 strike. If the trade size is too low in value there is a $US10 commission. Forex options expiring in the money are converted to a spot position but a trader may choose to convert it to cash by exiting at the mid price.

2. ThinkorSwim – www.thinkorswim.com

ThinkorSwim is located in the USA and are part of the Ameritrade Group. Their downloadable trading platform is second to none for options and includes advanced options analysis capabilities which makes them one of the best forex options brokers around. Unfortunately, you cannot join ThinkorSwim if you are a UK resident but you can from most other countries. The way you trade forex options with ThinkorSwim is to select options on futures, followed by the currency of your choice. Options on currency futures are not as liquid as stock options but you can utilise some of the more popular option trading strategies with them.

2. IG Markets – www.igmarkets.com

IG Markets are a UK based brokerage firm listed on the London Stock Exchange but they have offices in all major trading countries. Their main focus is CFDs (“contracts for difference”) but they also include option trading on all the major forex pairs. Their platform however, doesn’t seem to be set up for more advanced options strategies, only simple open positions – but it now includes some binary options. You could “leg in” to an option spread or a straddle on currencies but risk slippage in the process. Nevertheless, they are a forex options broker worth considering if you only want to trade simple directional positions.

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