The Trading Compass Download Tips to Understand Currency Options Trading

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There are many different kinds of currency options trading. If you are just entering Forex trading, you will want to research and understand how options trading works and the risks involved when you trade them. There are over three billion options traded per year and, while there are some benefits to this type of trading, most Forex brokers do not allow traders to sell options contracts without a high level of capital for protection because of the risk involved. In other words, there is a lot of risk involved in this type of trading and you want to be really sure about how to be successful at it before you start.

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Remember, we are talking about trading currency pairs. The most common options trading is called the "standard" or "vanilla" trading. It is very straightforward and involves the face amount in dollars, a put/call, and expiration, a strike (that's what the trade will be) and an exercise. So, let's break this down to see what it means. The option put/call is the right to buy or sell a currency pair at a given exchange rate at some time in the future (the expiration date). A trader has a right, not an obligation to sell. If the put rate runs out of money, the options expire and are worthless. The expiration dates are usually set at one week, one month, three months, six month, and twelve months.

If the exercise is "European" it means that it can only be exercised on the last day of its life. When it is exercised, the currency option triggers a SPOT or cash trade done at the strike price and for settlement on the SPOT value date. If the exercise is "American" it can be exercised at any time before the expiration date. It might be valued using a variety of numerical approximation techniques or it can be priced using binomial option-pricing models.

Exotic options trading has some non-standard features. The most popular of these is the "barrier option" and "knock-out option" These include a barrier exchange rate (out-strike) that kills the option if breached at anytime during its life (before the expiration date).

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Other types of options trading includes Double Barrier currency, Binary, Double Barrier Range Binary, Average Rate currency options, Quantos Options (for hedgers), and Compound (options on options). Now, this is by no means a complete list of all the types that are used. There are many hybrids and variable options that are also traded.

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