FX options may sound like a complex and complicated financial term, but in reality, they don't have to be effects. Options can be a useful addition to any investment strategy, whether it's a simple directional play that simply a currency pair moving higher or lower, or a large portfolio. FX options can be used as a direct investment to, for expressing a view in the underlying market, but they can also be applied as a hedging tool to be used in conjunction with existing positions, effects options.
Therefore give investors increased flexibility. There's allows you to tailor the risk profile of your positions to match any market view that you might have. You can use ethics options to express a view on a market moving higher, moving lower, or even from market that's moving sideways. FX options can also be used to express a view on future volunteer.
For example, if you believe the ethics market is about to move, but unsure about the direction you can structure your portfolio to benefit from a move in either direction. Furthermore, FX options offer the ability to leverage your positions and therefore significantly increase the potential profits. So let's look at how effects options are.
When we trade FX spot, we buy one currency and simultaneously sell another at whatever the market price is at that time spot refers to the current price. If the currency report rises in value against the currency we sold, we make money. And conversely, if the value falls we lose. An option on the other hand is about trading the currency pair in the future.
And only if the price is in our favor at that time, it's the possibility of trading the currency, paying the future at a predefined price, but it's not an application to do. The basic and most common options type is called a vanilla option. And there are two types of vanilla options call options and put options.
A call option is the right to buy a currency pair at a certain date in the future referred to as the expire date of the option and at a certain price. This is known as the strike price of the option. Buying a put on the other hand gives you the right to sell the underlying currency pair at the strike price on the expiry date effects options are very flexible.
You can choose exactly which strike fits your strategy and how long you want the option to learn. The combination of different strikes and expired dates will determine the price or premium of the option. In other words, the price you have to pay in order to take the option. We'll take a look at this in the next few pages.
A call option is a contract which allows the investor to buy a specific amount of the underlying currency pair at the time that the option is. The maturity of the option and the strike price are predefined. And both of these paramitas impact on the price, the option to buy the underlying currency pair is exactly what it sounds like an option.
It is not something you are obliged. If the underlying currency power treating above the strike price at the end of the option contract, then the investor can use the right and exercise the option to buy the currency pair at the strike price. If the underlying spot price doesn't reach that level and continues to trade below the strike price, then the investor can simply choose to let the option expire without doing anything.
This basically means that the investor gets the upside potential on. Without the downside risk. Let's take a look at an example. We're looking at Euro dollar spot, currently trading at 1.1 Siro Siro Siro. We expect the currency pair to trade high over the next two weeks and therefore set a target at 1.1300.
To express our market view. We buy your dollar call option with a strike at 1.105 Ciro and an expiry date. In two weeks time, the price of the option is 50 pips. So if we buy this option for notional value of 10,000 Euro dollar, then the premium of the option will be 10,000 times serum 0.0050, which equals $50.
If after two weeks, your dollar is trading below 1.105 Ciro. Then we will let the option expire. There's no point in buying your dollar spot at 1.1050. When we can buy it cheaper in the market, the premium we paid for the option will be lost. Notice that the premium is the maximum amount you can use when buying an option.
On the other hand, if you're a dollar trades above 1.1050, then we should exercise the option, but we need it to trade above 1.1100 to make a profit on the strategy. This is because the price of the option was 50 pips. With your dollar reaching our target at 1.1300. After two weeks, we can exercise the option and buy you a dollar spot.
At 1.105 Sera. This will give us a profit of 250 pips on the option. Minus the 50 pips we paid in premium. So 200. So investing in Euro dollar via FX options guaranteed a maximum loss of 50 pips, but had a potentially unlimited upside,
a put option is a contract that allows the investor to sell the underlying currency pair at the strike price when the option expires. So this is the exact opposite of a call option. This is an option to sell the currency pair and not the obligation. Put options can therefore be applied to express the view that a specific currency pair will trade lower.
And again, the maximum loss on the option is the premium paid. The potential profit. On the other hand is unlimited.
We think Aussie dollars over valued and would like to express this in our portfolio. Well, we could sell Aussie dollar spot. This means we sell it. The current market price. The only problem is that it leaves us with open risk on the upside. Most traders have been in a situation where their stock loss level has been hit due to temporary volatility only to see a correction in the market back towards your time.
The right view of the market, put a lost instead of a profit. So instead we buy an option Aussie dollars currently trading at 0.750 Sera. We talk at a move to 0.700 within two. We buy an Aussie dollar put strike at 0.7300 expiring in two months. The cost is 100 pips. During the two months, we don't have to worry about a stop level at any spot level above 0.73700.
We can just let the option expire, which leaves us without a position. The max loss is cat that 100. Should Asana reach our target. After two months, we can then exercise the option and sell at 0.73 Sera Sera. The strategy we'll learn as 300 pips minus the 100 pips we paid for the option. The profit and loss chart clearly shows the advantages of using effects.
Options. Maximum loss is limited, so we don't need a stop on our position. And at the same time, the potential profits are unlimited.
The FX market has changed significantly over recent years and liquidity gaps now happen on a more regular basis. This increases the risk of slippage on your stockholders slippage is where due to lack of liquidity, the stockholder gets filled at a worst level than India. FX options have the unique characteristic that they give investors full benefits from move in the right direction.
But with only limited risk effects, options are therefore a powerful tool for investments, both the us directional place, but also in combination with an existing effect spot. On the chart, we identify a support line for sterning dollar. At 1.4 Sera Sera Sera. We buy a spot position at 1.4 Sera to zero in anticipation that the 1.400 level will hold.
But we place a stop at 1.3985 in case it doesn't. Unfortunately, the support levels eventually broke and the market dropped from 1.4 Sera Sera Sera down to 1.39 Cirrus zero in one move. As a result, the stop order was triggered at 1.3985, but the first tradable price in the market was 1.39 Cirrus Ciro.
And this is where the order gets filmed. So the max loss on the trade changes from 35 pits to 120 pips. And we're taken out of the position as an alternative to placing the stop order. We could have bought a Sterling dollar put with a strike at 1.3985 with expiring when we had a cost of 30. This protects us in case spot trades below 1.3985 and leaves a max loss of 35 plus 30 pips, which equals 65 pips.
So even though the maximum loss is higher than we had with the spot strategy, it still has a few.
So let's review some of the advantages placing stops in the FX spot market. Won't protect you against gaps. So drops in the market. However, buying FX options will provide protection with FX options. There is no slippage. We can always sell spot at 1.398. Using FX options as protection instead of a stop order also means that we don't have to close out the spot position.
We can instead keep the long spot position in our book or portfolio. Should the market move higher? We can still benefit. We can still profit from the spot position. If spot moves all the way to 1.4 1 500 0, we could own 130 pips from the option. Minus the 30 pips we paid in premium equals our 100 PIP profit.
The options will come at a cost which needs to be added to the maximum potential.
Leverage is one of the biggest benefits of trading options, leverage and financial markets means creating potential for bigger gains whilst risking a smaller amount of your capital. So, how do we apply leverage to arm strategy? One of the primary factors, which determines the cost for buying a particular FX option is the distance between the chosen strike price and the price of the underlying currency.
The further way from the underlying market, the strike of the option is the cheaper the option gets. Choosing a less expensive strike means that you can increase the notional amount of the option without increasing the total cost. For example, buying an option on 10,000 year old, dollar 30 pips, what costs $30 or buying an option on 30,000 Euro dollar that 10 pips put also cost $30.
As investor, you can choose many different strikes that will fit your market view. So make sure you explore the opportunities to get the most out of your investments.
So let's have a look at an example, your dollar it's currently trading on 1.10 Siro Siro and we expect a rally to 1.160 Ciro within a month. The maximum potential loss we want to risk on the trade is $15,000. So what's the best strategy one by your a dollar spot at 1.1000. Stop. At 1.0850 in one media notional to buy Euro dollar Corp 1.1000 cost 100 pips in 1.5 million notional.
Three by your a dollar Corp, 1.1250 cost 50 pips in 3 million notional. The best strategy depends on the target. The advantage of using leverage via FX options is clearly shown. And if we reach our target at 1.1600, then the profit from the three strategies would be 60,000, 75,000 and 90,000. At 1.2 Cirrus zero zero.
The profit from the three strategies would be 100,135,000 and 210,000. The option strategy also adds more flexibility to your investments. In this example where the volatility is rather high, there's also the risk that your a dollar will trade down to 1.0850 before heading back home. If that is the case and spot trades back to 1.1600.
At the time of expiry, then the profit and loss on the three strategies would look very different because the spot position would have hit the stop level. When you expect increased volatility in the market, investing via FX options can often turn out to be the optimal solution. Along with the possibility to leverage, you can also get protection against temporary moves in the other direction.
When you sell an option, you no longer have all the benefits. For example, you can no longer choose whether to exercise the option or not. Instead, you have to await the decision from the owner of the option. Should the owner decide to exercise the option? You are then obligated to enter into the transaction.
Uh, sell off the option. You were initially earn a premium from the option, but you may also get a liability in the future. Should the owner choose to exercise? Let's look at an example, your a dollar is trading at 1.1, Cirrus zero, zero, and we sell of 1.120 Ciro Cole option at 30 pips expiring in a week.
Initially we earn the 30 pips. And if you're a dollar trades below 1.1200, when the option expires, then we can keep the 30 pips and the option expires worthless. However, if your dollar trades above 1.1200 at expired time, then the owner of the option will exercise the option. And we have the obligation to participate in the trade and offer him to buy your a dollar from us at 1.120 series.
So when shorting the Nyla options, the maximum profit is fixed that the premium amount, the potential loss on the other hand is unlimited. Vanilla options can be put to great use in combination with an existing spot position. The most straightforward approach is to buy an option and use it as a hedge against the spot position.
However, expressing your view via spot position without buying protection informed member an option can in many cases be the optimal investment strategy for you. As long as you have an exit strategy in place. In these cases, you could actually benefit from selling an option, but this time selling an option in the same direction as your spot position.
So long spot seller call short spot seller put by selling the option. You will initially earn a premium. This premium can be used in your strategy as a way to improve your entry on the spot position. If you are along your dollar spot from 1.085, Sarah, and you choose to sell a 1.105 Sera your dollar call option with the same notion on the Mount.
As the spot position at a premium of 50 pips, then you can incorporate the 50. As part of your stop-loss strategy and place your order, 50 pips further away you use the short option as a take profit level for your spot position. You choose the strike price of the option to be equal to the target for your spot position.
If the option gets exercised, then you will sell spot at the strike. So you made money on the spot move. You made money from selling the option and you decrease the likelihood of getting stopped.
FX options may sound like a complex and complicated financial term, but in reality, they don't have to be an option. On the other hand, it's about trading the currency pair in the future, and only if the price is in your face. At that time, it's the possibility of trading the currency pair in the future at a predefined price, but it's not an obligation to do so.
You can use FX options to express a market, moving higher, moving lower, or even for a market that is moving sideways, affects options. Have the unique characteristic that they give investors full benefits fund move in the right direction. But with only limited. Affects options are therefore a powerful tool for investments, both as directional plays, but also in combination with an existing FX spot position.
When you expect increased volatility in the market, investing via effects, options can often turn out to be the optimal solution. Along with the possibility to leverage. You can also get protection against temporary moves in the other direction. When you sell an option, you no longer have all the. For example, you can no longer choose whether to exercise the option or not.
Instead you have to await the decision from the owner of the option. Should the owner decide to exercise the option? You are then obligated to enter into the transaction.