Hedging your bets against the future: the forex option
All speculation-based markets are full of uncertainty, and none more so than the forex market. A currency might be strong and vibrant today, weak and sickly a month from now. One way to guard against major fluctuations like that is through forex option trading.
A forex option is when you buy the right — but not the obligation — to buy or sell a particular currency at a particular rate any time between now and the expiration date of the option.
Let’s say you’re worried that the Japanese yen is going to drop in value sometime in the next six months. You might buy an option that basically locks in the current exchange rate for whatever period of time the option seller allows, usually anywhere from 30 days to six months. You set a number of yen, too. Say you choose 10,000 yen at a rate of 116 yen per U.S. dollar for three months. The option basically says, “I may want to sell 10,000 yen sometime in the next three months, but I’m worried the yen is going to devalue in that time. So I’ve locked in this rate of USD/JPY 116.”
Then three months pass. If your prediction was correct and the yen has weakened in that time — say it’s now USD/JPY 122 — then you exercise your right to sell 10,000 yen at the rate you bought three months earlier. Everyone else selling yen today (everyone who didn’t have a forex option, that is) is selling it at 122 per U.S. dollar, and you get to sell it at 116.
If, on the other hand, the yen has stayed the same or gotten stronger, you are under no obligation to actually sell that 10,000 yen your option talked about. You can simply do nothing, and all you’ve lost is the premium you originally paid for the option.
Ah yes, there is a premium. Brokers who sell forex options charge a fee for the privilege. Think of it as insurance; calling it a “premium” certainly fits. The price of a forex option for 10,000 yen for three months might be $200, which you must pay up front. If the yen drops enough in value, you’ll hopefully turn enough of a profit to make up for the $200 you had to pay. If it increases in value, and you wind up not exercising the option, all you’ve lost is the $200 premium.
Forex option trading used to be done only by major banks and corporations, but now many brokers who cater to individual traders offer the service, too. If you’re a heavy-duty trader, a forex option is definitely something to consider to guard against future setbacks in the currency you hold.
Trading Options And Futures – Comparing The Two Types Of Contracts
In trading, it is quite common for the terms options and futures to be used interchangeably. Although these two contracts have a lot of similarities when it comes to principles, they are actually two very different things and therefore interchanging them when conducting trades in the market can be a very lethal mistake for anyone.
Let us learn the differences between these two contracts in order to prevent making the wrong decisions in buying and selling rights for stocks or commodities. Through this, we may just be able to prevent risks and maximize chances for profit.
What Is An Options Contract?
An option is basically the right to buy or sell a specific amount of stock, currency, or whatever commodity offered in the market. This contract basically allows an individual to enjoy, but to necessarily become obligated, to exercise these rights. This contract can only be valid for a specific period of time, and commodities traded can only be bought and sold at a certain fixed price.
What Is A Futures Contract?
On the other hand, a future is a transferable contract that requires the delivery of a certain stock, currency or whatever commodity traded. Like an option, the delivery of the trade is done through a fixed price stated in the contract and within a time frame, so one should not go beyond the expiry date.
However, it is very important to take note that a holder is obligated to exercise the conditions of the contract unlike in options where the holder can have the liberty of deciding.
The Differences Between Options And Futures
Aside from the fundamental difference between the two contracts on rights and obligations, there are also other differences that include commissions, the size of underlying stocks or commodities traded and how gains are realized.
In a futures contract, an investor has the liberty to sign into the contract without paying upfront. However, an investor cannot take hold of an options position without paying a premium to the contract holder. The option premium therefore serves as payment for the privilege to not become obligated to purchase the underlying commodities in cases wherein there are unfavorable shifts in prices.
Another major difference between options and futures is also the size of the underlying positions that can be traded. Usually, futures contracts would include much larger sizes for the underlying positions as compared to that included in options contracts. Because of this, the obligations included in futures make it riskier for a contract holder to trade due to the possibility of losing so much.
Lastly, the two contracts differ with how gains are received by parties involved. For options contracts, gains can be attained in three methods. Either the holder exercises the option, purchases an opposite option, or waits until the expiration date arrives to be able to collect the difference between the price for asset and the strike price, so he or she could get profits. However, profits for futures contracts can only be realized by either taking an opposition position or through the instant change in the value of positions at the end of each trading day.
Knowing about the differences between an options contract and a futures contract can help broaden your knowledge in stock trading, and this can surely prevent you from making the wrong decisions if ever you decide in joining this particular arena.
Remember to never trade without doing your research and fully understanding what contracts you are dealing with. If you just take the extra step to acquaint yourself, then you just might be able to spare losing so much money.
Stock Option Trading – Starting Out On The Basics
Stock option trading is not an advisable endeavor if you are new to the whole stock market game. If you delve into it unprepared, chances are, you may lose a lot of money as fast as you can make it. But doing your homework and starting out from the very basics can help groom you to be able to play in this complicated game. After all, this is a powerful investment tool if you plan to stay long in the stock market business.
What Are Stock Options?
First and foremost, it is important that you do not confuse an option with an actual stock. A stock option is actually a contract that gives the rights to either buy or sell the securities or commodities of a certain stock at a fixed price and within a specified time. When you trade options, you are basically just trading your privileges for securities or even certain merchandise involved, but not the stock itself.
These stock options are actually very important in the market because they provide advanced investors with extra opportunities that could pave way to better returns in doing business within the stock market. Investors usually make use of these rights to evade from price declines, to give insurance for the price of a future purchase, or even to help them speculate future stock prices.
There are two kinds of options –call options and put options. Call options basically give purchasers the privilege to buy underlying stocks, while put options allow the purchaser to sell the underlying stocks.
How Do You Exercise Options?
If you already own an option, you can exercise buying or selling its stock any time on or before its expiration date. This would allow you to trade the stock at a set price regardless of what the current market price is for that particular stock.
And thus, you can have the privilege of buying or selling stocks in cases wherein you fear that prices might get too high or too low for you. In this way, you have certain degree of insurance on the investments that you make. A lot of investors simply make trades without any intent of possessing the underlying securities.
How Do You Trade Options?
In trading options, also take not that the pricing may be extremely complicated. But it will basically depend on two major factors –the pricing of the underlying stocks and the amount of time remaining within the contract.
The price for principal stocks that accompany the options directly affects the price of the option. If the demand for the stocks is high, the price for the options will also go up and vice versa.
The amount of time left within the contract for an option also determines the price. As time expires, the price for the option may go down as it may become less desirable.
Take note that in the trading options game, investors use various trading strategies, which may all be very risky and complicated. And so, to become really successful in your attempts to profit from option trading, make sure that you at least familiarize yourself with the different strategies and consult experts who can give you good and reliable training.
Stock option trading can be a very strong investment tool for anyone who does business in the stock market. However, keep in mind that for someone who is not as familiar with the different strategies and if you are new to the stock exchange, this may be a very risky endeavor to take on. And so, utmost caution for beginners is highly advised.