Options trading is a popular method of trading commodities and stocks. Forex options, however, are not as popular among retail traders. In this blog we are going over why that might be and how options can be used in Forex. So let’s get right to it.
What are options?
It is a contract that gives the contract holder the option to buy or sell a commodity or underlying asset at a given price.
The difference between options and futures is that there is no obligation when it comes to options. A trader with an options contract is not obliged to buy or sell at that price and deliver an asset.
How options trading works in Forex
If a trader thinks a currency pair, say EUR/USD, is going to increase in the near future but they’re not sure exactly when, they can buy an option for a premium at the current price for a given amount of time.
This means that should the value of EUR/USD increase, as they predicted, during the time that the option contract is valid they can buy at the pre-decided price and sell at the higher price. This is called exercising an option.
On the other hand, if the value of EUR/USD goes down the trader will not go through with the contract and will just let it run its course and expire. In this case, the only payment will be the premium paid to buy the option.
Why aren’t options more popular in Forex trading?
From the above explanation it must seem like a very lucrative and safe trading arrangement. So why aren’t options more widely available and why don’t more retail Forex traders buy them?
For one, not all brokers offer options. Secondly, you need an options account in order to buy them. And let’s really consider the benefit here.
In Forex trading, brokers don’t take heavy commissions unlike stocks. This is because in Forex there is no delivery of an asset required. In stocks commissions are often high.
Essentially then, if you buy an option in Forex you have to pay a little as the premium as opposed to buying the pair directly and risking that amount. If you set a stop loss, the money you invest in a currency pair will most likely not be too far from the premium you would have paid to buy an option for the same pair.
Plus, you need to have an options account to be able to buy them.
This means that for retail trading and especially with day trading, in which the spreads are usually quite tight already, options don’t offer the kind of value that would be cause for deviating from direct buying or selling.
As long as you set a stop loss and limit your losses, exposing only a set amount per trade, options will most likely not be too attractive.
In stocks, options trading is popular and even in Forex it is often used by hedge funds. Retail traders generally tend to use the simpler method of buying or selling a currency pair since it doesn’t involve commission and if we think about it, it’s not too different from paying a premium for an option.
We hope this blog helped clear up the idea of options in Forex trading. If you have any questions, please feel free to ask.