What are forex options?

Options are often associated with the stock market however options are also a derivative associated with the forex market. Options are a tool used to limit risk and increase profit. Options are available as either a call/put or a SPOT (Single Payment Option Trading)

A call/put gives the buyer the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. As an example a GBPUSD forex option could be defined by a contract giving the owner the right but not the obligation to sell £1,000,000 and buy $2,000,000 on April 1st. The option would be exercised if the pound is weaker and the dollar is stronger on April 1st. For this example we will say the rate is 1.9000 on April 1st allowing the owner to sell GBP at 2.0000 and immediately buy it back in the spot market at 1.9000, making a profit of (2.0000 GBPUSD – 1.9000 GBPUSD)*1,000,000 GBP = 100,000 USD in the process. If they immediately exchange their profit into GBP this amounts to 100,000/1.9000 = 52,631.58 GBP.

Single Payment Options Trading (SPOT) options allow you to enter a trading scenario and pay an option cost (premium quote). If the scenario occurs then the buyer receives a payout, if it does not the buyer loses their option cost. SPOT options have the benefit of defining more scenarious when compared to a call/put, their downside is a higher option cost.

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Tags: Derivative, Options, SPOT