In the trading world, options trading refers to the trading of conditional derivative contracts which allow its holders to buy or sell securities at a chosen price. Sellers charge a premium on options holders for the right to sell. These options contracts are available in a variety of different asset classes including foreign exchange.
Forex options refer to contracts that give one party the right to buy or sell a fixed amount of currency at a specific rate on a future date. The buyer of an FX options contract has the option but not the obligation to exercise his/her right to sell the contract. It acts more like an insurance policy. While the price of the contract is calculated by using statistical assumptions and represents the measure of risk.
FX Options are used by individuals, major financial institutions and large corporations to hedge against adverse movements in exchange rates of currencies. In addition, corporations use FX options as a way to hedge uncertain future cash flows in a foreign currency. As a general rule of thumb, an investor buys “calls” when they think the currency rate will rise or sell a “call” if they think it will decrease. Similarly, they will buy “puts” if they think the exchange rate will fall or sell them if they expect the price to rise.
Example of FX Options
To clearly understand the concept of FX options, let’s take a look at an example. Let’s say your feeling that the EUR/USD pair will increase in value in future. You purchase a currency call option on the EURO at a strike price of $115. However, when you purchase the contract the EURO’s spot rate is $110.
Now, at the time of expiration of the options contract, the EURO’s spot price is $118. This means that the currency option has expired “in the money”. You will thus receive a profit of ($118-$115)*100=$300. The premium you pay for the contract will also be deducted.
Why trade FX Options?
You can look to trade FX options from a regulated and reliable broker to gain the following advantages:
- You can choose the amount, the strike price and the expiry date of your choice when you buy FX options.
- Since you have to pay the funding cost and premium upfront, you know the maximum cost of the contract beforehand.
- Since your downside risk is limited, you know your worst position.
- You can also allow the option to lapse and not commit to exchange currency at the strike price if it is in your favour.
- Certain options contracts will allow you to choose more than one delivery date for specified amounts. This can be used to hedge a series of currency exposures with just one options contract.
- Depending on the broker you’ve chosen FX options are available for almost all major currencies and for small amounts.
- You can sell the option back to the writer for fair value at any time before expiration.
- Options are best used in case of uncertain cash flows since the risk is limited to the extent of the premium you pay.
FX Options Trading in India
FX trading in India is a complicated topic as the rules for FX trading activity in the country are highly restricted. Despite all this, the SEBI (Securities and Exchange Board of India) and the Reserve Bank of India (RBI), the two main regulatory bodies of the country, have relaxed a lot of rules for traders. Indian traders can trade FX options exchanges such as the National Stock Exchange or Bombay Stock Exchange. Additionally, they can trade using brokers registered under the SEBI or online brokers which offer local deposit options.
A common question being asked among Indian FX trading circles is – how profitable is Forex option trading in India? While there are no direct answers to this, profitability depends on your abilities as a trader and the broker you choose. Always remember that trading FX options are far riskier than other FX derivatives such as Contract For Differences. That being said, here are some of the best brokers that offer FX options.
- IQ Option
IQ Option is a name that comes up in trading circles when looking for binary options and CFD trading. Founded in 2013, the broker has a very low minimum deposit requirement that caters to novice traders. The broker is regulated by the Cyprus Securities and Exchange Commission (CySEC) and is designated as a Cypriot Investment Firm. Some of the features of this options broker are as follows.
- There are 49 different options when you trade with IQ Option consisting of binary options and digital options.
- Binary options are intuitive and accurate instruments that are perfect if you are trading outside the EU.
- Digital Options allow you to speculate on the price movement of any asset, similar to CFDs.
- FX Options is similar to binary options but meant for traders in the EU.
- There are two types of accounts available: the VIP and the standard account.
- CMC Markets
CMC Markets is a UK-based binary options provider which boasts more than 10,000 tradable products and clients from more than 75 countries. The broker offers options in major currency pairs such as USD/JPY, GBP/USD and EUR/USD. What’s impressive is that it is one of the very few binary options brokers that is regulated by the FCA in the UK. Some of the features of this broker include the following.
- You can trade binary options at CMC markets through countdowns, spread betting and CFDs.
- CMC Markets provide over 80 technical indicators, 60 candlestick patterns and 40 drawing tools.
- The broker offers a wide range of educational resources that you can use to familiarise yourself with FX options trading.
- Customer support is offered via phone.
- AvaTrade
Founded in 2006, AvaTrade is a well established CFD/FX broker which also offers options on different instruments. You can access 55 FX pairs, 17 commodity CFDs, 20 equities indices, and several cryptocurrencies once you decide to sign up. It is regulated by a myriad of regulatory bodies including the ASIC, FSA and the Central Bank of Ireland. Some of the features of this broker include the following.
- AvaTrade offers 46 currency pairs for options trading including USD/JPY, GBP/USD and EUR/USD.
- The broker has a dedicated account type for options trading called Vanilla Options account which you can use to trade on the broker’s options trading platform, VanillaOptions.
- Your options account can be used in conjunction with the broker’s proprietary AvaOptions trading platform.
- AvaOptions comes with a selection of 13 default trading strategies that you can use.
- IG
IG is one of the most regulated options brokers that you will find, providing a combination of industry-leading education, competitive pricing and several tradable products. It has more than 200,000 traders registered under it and has executed more than $1.47 trillion in value since its exitence. Some of the features of this broker include the following.
- IG Markets will allow you to trade options on FX along with major indices, shares and other asset classes.
- The broker is regulated by the Financial Conduct Authority (FCA) of the UK.
- It offers customer support via Live chat, phone and email.
Final Thoughts
FX options can give you trading success only if you apply them properly. As a very high-risk instrument, you will have to grasp the concept thoroughly before starting to trade. The broker you choose also matters, as the number of fraudulent entities in the market has grown. You should thus always look to sign up with regulated and reliable brokers who can offer you some kind of investor protection when dealing with FX options.