|
- Protecting profitable spot forex positions for any period of time
- Preventing losses on spot positions for any period of time
- Generating extra income on spot forex positions you buy or sell
- Generating extra income without owning a spot forex position
- Profiting from forex market movement in either direction when no trend exists
- Trading with a known dollar amount at risk and known potential reward every time
- Making money in a sideways (non trending) market
Any ForexEarlyWarning subscriber can join us for our weekly forex webinars where we will present the benefits of currency options and when and how to use them. There are several currency options brokers that offer satisfactory trading platforms with "plain vanilla" puts and calls that can be used with the Forexearlywarning.com educational material.
Things to remember about Options:
Options are an asset class like stocks, bonds, mutual funds and commodities, they are in their own asset class.
You can own an option without owning a currency pair.
You can own an option with a currency pair. With a covered call you have a buy position and a short option position in the same account.
In all of the examples in this lesson we specify 1 standard lot (10 minilots) equal to 1 option contract in the trade examples, but you can trade options on minilots if you wish.
At-the-money - An option contract with a strike price at (or very close to) the underlying rate; also, the closest strike price to the underlying rate. If you purchase 1 call option at 1.5500 you bought a call at-the-money
Exercise and AssignmentAll puts and calls that are in the money are exercised the day of expiration the specified time with a spot position, there is no premature assignment. Out of the money options expire worthless. If you sell a covered call at 1.5500 on the EUR/USD and the price is above 1.5500 at expiration your spot position will be removed from your account and you will keep the premium.
Hedge - The purchase or sale of options or futures contracts as a temporary substitute for a transaction to be made at a later date. Usually it involves opposite positions in the cash, futures or options market. If you buy 1 regular lot of the EUR/USD then 1 put option at 1.5500 you have a perfect hedge or married put.
In-the-money - An option contract that has intrinsic value. If you buy a put option at 1.5500 and the EUR/USD drops, the put goes into the money.
Intrinsic Value - The difference between the strike price and the underlying fx spot contract rate (American Style Options) or the fx forward rate (European Style Options). The intrinsic value represents the actual value of the option if exercised. Please note that the intrinsic value must be zero (0) or above - if an option has no intrinsic value, then the option is simply referred to as having no (or zero) intrinsic value (the intrinsic value is never represented as a negative number).
If you buy a put option on the EUR/USD at 1.5500 strike price for a premium of $500 this is all time value and no intrinsic value. If the EUR/USD drops 50 pips and the options is worth $1000, $500 is time value and $500 is intrinsic value (in the money amount).
Option Contract - A financial contract giving the buyer the right, but not the obligation, to purchase or sell a specific forex contract (the underlying) at a specific price (the strike price) on or before a specific date (the expiration date). The amount the buyer pays to the seller for the contract rights is called the "premium." This is for someone who buys a put or call.
Option Premium - The amount the buyer pays to the seller for the rights of an option contract.
Out-of-the-money - An option contract having no intrinsic value. EUR/USD trading at 1.5500, buy a put or call at 1.5500 strike price has no intrinsic value. If the EUR/USD rises above 1.5500 the option is out of the money.
Strike Price – Exercise price.
Uncovered - If you sell a put or call on the EUR/USD with no underlying spot position you are “naked” or uncovered. Don’t do this unless you understand the risk.
Strategy #1 - Selling Covered Calls Out of the Money
Situation - You currently own a spot position in the GBP/JPY (for simplicity 1 regular lot) that you bought at 211.00. The pair has moved up 200 pips but is stalling at resistance at 213.00 you think it will stall for a week or so then continue higher but you want to profit from this situation.
Action - Sell a covered call at a strike price of 213.00 out 7-10 days to expiration, estimated premium would be about 2.00 which means:
You are currently up about 200 pips on your spot position so this is $2000 in profit ($10 payout for simplicity), you get a premium of 2.00 which is another $2000 in profit. You just doubled your profit and are now guaranteed $4000 in profit if the GBP/JPY continues higher or stays just below 213.00.
After you sell the calls out of the money there are three possible outcomes
1. The GBP/JPY consolidates below 213.00 for a couple of days but continues higher and you take no further action in your account. Your profit limit has a ceiling of $4000, if the GBP/JPY spot position continues higher you cannot profit from this and you are called out of your spot position at expiration. Maximum profit is $4000.
Called out means that your GBP/JPY spot position will be removed from your account after expiration, you no longer own the GBP/JPY spot position after expiration, you were called out.
2. The GBP/JPY drops unexpectedly so you need to know your break even point because you own a spot position. Breakeven calculation, you bought the GBP/JPY at 211.00 and it is at 213.00, which is 200 pips of profit ($2000) after you sell the calls your breakeven price goes from 211.00 to 209.00. The selling of the call protects you by an additional 200 pips. You can install a price alarm and stop order at 209.00 to notify you of the price drop and subsequent liquidation of your spot position, you can also buy back your calls at that point.
3. If the GBP/JPY stays below 213.00 until expiration then starts to rise you keep the $2000 premium and additional profit from the GBP/JPY spot position rising. Your cost basis is now 209.00 and it can get extremely profitable here.
Strategy #2 - Selling Covered Calls In the Money and Buy-Writes
Situation: You are a little late coming to the computer in the morning session but the GBP is strengthening across the board and is starting a new move.
Action: Buy 1 regular lot of the GBP/USD at 1.9800 and sell covered calls at a strike price of 1.9750 for two weeks out. Estimated premium is 90 pips. $900 goes into your account. Check quotes it could be slightly lower. By comparison selling calls at 1.9800 would give you a $600 premium.
After you sell the calls out of the money there are three possible outcomes:
1. The GBP/USD continues higher, you keep $400 net premium.
2. The GBP/USD goes sideways but stays above 1.9750. You keep $400 premium.
3. The GBP/USD unexpectedly drops significantly to below 1.9710 which is breakeven price. You could set a price alarm at 1.9720 and a stop order at 1.9710 for your spot position which is breakeven on the deal. If the GBP /USD keeps dropping you break even. Breakeven is 30 pips higher if you had sold calls at 1.9800.
Strategy #3 - Straddles and Strengles on Volatile News Events
Situation: You see a volatile news event coming and you don’t know which way the pairs will go so you buy a straddle to profit from movement in either direction.
Action: Buy 1 put and 1 call on the GBP/USD at the money for an estimated cost of $1100 two days prior to the volatile news event ($550 each).
After the news:
1. The GBP/USD moves up or down by at least 55 pips to breakeven, anything past there would be net profit, when most or all of the movement is over close out the straddle.
2. The GBP/USD goes sideways but does not move enough to produce a net profit, wait until expiration after the puts and calls expire and create a covered put or call from the position assigned. This will repair or minimize the loss that should have occurred
Strangle – Buying equal amount of puts and calls at out of the money prices.
Everything is the same as the EUR/USD example above however you would use a strike prices out of the money, so then your premiums would decrease.
Benefits of straddles - Unlimited upside.
Straddle certain news announcements that are historically volatile and put on the trade about 48 hours in advance at the money and make it expire the day of the announcement and closes out roughly 2 hours after the event regardless of the outcome. (MP)
Below is the compiled statistics I got based on last 5 years statistics:
1. Non Farm Payrolls – Unemployment Average Move: 125 Pips
2. FOMC Interest Rate Decisions Average Move: 73 Pips
3. Trade Balance Average Move: 62 Pips
Strategy #4 - Put and Call Protection
Situation: You see a volatile news event coming and you own a buy position that is strongly profitable and want to protect the profits ahead of the news.
Action: Buy 1 put option with custom expiration good for one or two days on the buy position.
After the news if the spot position drops in value you are protected by the put, if the spot position goes up you lose the value of the put but the spot position increases in price. This is like an insurance policy on your profits. You can do the exact opposite with a sell position and a protective call option.
Strategy #5 - Demo Accounts and Demo Trading - In the webinar lesson related to currency options we suggest several currency options brokers and provide you with a list of brokerage options. You can open an options demo account with any of them and paper trade. Paper trade strategy #1-4 and you may be able to use options as part of your forex trading arsenal.
Strategy #6 - Selling a Currency Pair Versus Option Trade
If you are ready to sell a currency pair (spot trade), you have two other choices, you can either buy a put option or sell a call option and you are essentially accomplishing the same thing but you will not own a spot position at all. If you sell a call you will receive a cash premium in your account immediately and if the pair keeps dropping you will keep all of the cash premium in your account at expiration. To exit the trade just wait until expiration and the option expires worthless. You can also set a limit order to close out your call position for when it reaches a certain value. You can also set price alarms to notify you of any price movement back towards the strike price:
Example:
GBP/USD is trading at 1.4800 and you would like to sell it, instead you sell 1 call option at a strike price of 1.4800 good for one week, you will receive a cash premium in your account estimated at $_____. If the pair stays below 1.4800 for one week you keep the premium. Remember for this example you never buy or sell a spot position at all you are using an option instead.
Strategy #7 - Buying a Currency Pair Versus Option Trade
If you are ready to buy a currency pair (spot trade), you have two other choices, you can buy a call option or sell a put option and you are essentially accomplishing the same thing but you will not own a spot position at all. If you buy a call you will pay cash premium out of your account immediately and if the pair keeps rising the value of the call will appreciate. To exit the trade just wait until the pair stalls at resistance and cash out the call by selling it (close to sell). You can also set a limit order to close out your call position at a predetermined profit. If you buy an even number of calls you can close out half of your calls buy selling them. You can also set price alarms to notify you of any price movement back down towards the strike price. The advantage here is good in that the cost of the call option is less than the spot position.
Example:
GBP/USD is trading at 1.4800 and you would like to buy it, instead you buy 1 call option at a strike price of 1.4800, which is at the money, good for one week, you will pay a cash premium out of your account estimated at $_____. The GBP/USD rises and your option is now worth $________. You sell the option to close the position and keep the difference. If you pay a $600 premium, when the price increases to 1.4860 you will have a double before commissions, the option will be worth $1200. Not bad at all !!
When judging their possible outcome of an options trade just enter the paper trade and track the underlying spot position. Did the pair go up, down, or sideways after you entered? Record the results in your journal book up to expiration.
For example if you sell a covered call and the pair moves a lot higher you cannot lose money on this trade but will not participate in any further profit on the spot position. So no risk here.
However if you sell a straddle and the pairs moves beyond the strike price of the puts or calls that you sold your account is now at risk, you must monitor this type of trade with price alarms or entry orders to manage the risk in case of the unexpected movement, so the risk scenario here is much higher than the covered call scenario in the paragraph above which has almost no risk
If you have reached the point in your forex trading where you are ready for options, you are a likely a more advanced spot forex trader. You can go to the suggested currency options broker web sites and most of them have strategy discussions along with glossaries. A little bit of study and paper-trading and you will start to see the value of options along with the ForexEarlyWarning trading plans, knowledge of the trend, and the Forex Heatmap ™.
All puts and calls that are in the money are exercised the day of expiration at the specified time with a spot position, there is no premature assignment. Out of the money options expire worthless.
Currency Options Brokers
This is a review of available plain vanilla currency options brokers as of Monday May 10th, 2010
This is a listing of three options brokers that I have reviewed:
http://www.saxobank.com/en/pages/default.aspx SAXOBANK
http://www.cfosfx.com/ VAM FOREX
http://ikongm.com/Default.aspx IKON GLOBAL
If you don’t like any of these three here is a link to more currency options brokers.
http://www.forexturtle.com/lists/fx-options-brokers.aspx
Please check these choices out and set up a demo account to test any of the options strategies presented here.
With currency options at our disposal we can now trade the spot forex when it is trending and occasionally trade puts or calls when the situation warrants it. As trend traders we know sometimes the market goes sideways with no trend and now we more weapons in our arsenal to profit from sideways movements in the market and strategies to protect our positions. We are looking forward to assisting our clients succeed with currency options.
*Disclaimer:
Foreign exchange trading, foreign exchange investments and commodity futures trading and investments are not suitable for everyone. Forex trading and commodity futures trading carry a high level of risk and the possibility exists that you could sustain a loss of all or more of your currency trading or commodity futures trading investment. Before you decide to trade foreign currency options, trade foreign currency spot markets or trade commodity futures you should be aware of all risks associated with currency trading and futures trading. If you would like more information about the risks of forex trading, commodity futures trading and of online forex trading and online futures trading, please contact a CFOS/FX futures and forex broker to discuss online foreign currency trading risks and/or commodity futures trading risks in detail.
|
