Have you ever heard of a binary option? Don’t be discouraged if you haven’t, because even some seasoned traders somehow finish up going their entire careers without completely exploring this type of trading.
Mainly this is because of the fact that, till recently, foreign exchange options were mainly used by huge firms that had deals in multiple currencies and were seeking to hedge their likely losses and rein in their risks.
On a basic level, understanding forex options themselves is fairly simple. A choice is basically simply a contract that allows the holder the legal right to buy ( or in a number of cases, sell ) a selected currency at a pre-agreed price and a pre-agreed time, without regard for what the actual market price may be at that point in time.
of course, this is a very fascinating suggestion as it means that the holder of the option stands to gain if the price that they concluded to buy or sell a currency at is favorable compared to the market price at the time. As such, it should come as little surprise that there is an front-loaded cost for options to make it an attractive suggestion for both parties ( i.e. The holder and the writer of the option ).
In a nutshell, if you are holding a choice to trade US$ for Euros at 1.4 and the present market price is 1.6, then you stand to gain tons! If however the present market price is 1.2 or something then you might simply not exercise the option and all you would have lost is the initial cost.
Generally, the pricing and valuation system of options is pretty difficult, and so it can take time and experience to absolutely appreciate it. These days though, there is another sort of option that has popped up called the ‘digital option’, and that is seen to be more accessible by casual traders.
With digital options, you decide whether a given exchange rate is going to move up or down, and also decide what type of payoff you want. Assuming you think that the EU Buck ( which is trading at 1.44 will move to 1.46 inside four months, and you decide that you would like a payoff of $1,000, you’d then have to see how much a choice of that variety would cost.
For now, let’s just say that it would cost $100 and this would imply that if you’re right, you get $1,000, and if you’re inaccurate, all you have lost is the opening $100 that the option cost.
Fully appreciating the value of options is something that many small-time traders have a tough time with. Frankly, it could be a lot of a headache to control many options in multiple currencies, and so if you’re brooding about starting, just make it simple for now.
Later on, when you get a better grasp of the ropes, you can move on to bigger and more varied option investments.