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Currency Options Market

Let’s make a start and I will try to explain all the various types of currency options that are available for trading in the markets. I’ll start with broad generic groups, explain where and how you can trade them, and the risks involved, but please remember options trading in any form is really only designed for the more experienced trader, so please bear this in mind before you rush off to open an options account with a broker. Now, for the purposes of clarity and simplicity, from now on I propose to refer to two main groups of options which are as follows :

  • Vanilla – these are currency options that are listed and traded on an international exchange . These options can be freely traded and both bought and sold ( on exchange )
  • Exotic – these are currency options that are not listed on any exchange, and can generally only be bought, also often referred to as OTC ( over the counter ) Almost all retail forex trading is off exchange ( i.e. it is unregulated )

Vanilla currency options, are those that most closely resemble equity options. Options are contracts that give the owner  the right, but not the obligation, to buy or sell a specific amount of the underlying asset during a specified time at a specific price. For stock options in the US markets the amount is usually 100 shares. There are two types of option, a call option and a put option, and the buyer is called the holder, and the seller is known as the writer. If the contract is exercised by the holder then the writer has to fulfil the contract, by delivering the shares to the holder. If the option is a contract on a security with no physical delivery such as an index, then the contract is delivered in cash. Call holders are looking for the underlying asset to increase in value, and put holders for the asset to decrease in value. Option buyers pay a premium to the writer which is kept in all cases, whether the option is exercised or expires worthless.

There are two principle styles of options contract – the European style and the American style. The American style option can be exercised at any time prior to the expiry date, whilst the European style can only be exercised at expiry. The former is far more flexible, but with most vanilla currency options, these are generally European style. In the last twelve months, many of the world’s largest exchanges have begun to realise that there is a market for smaller retail currency speculators and traders in “on exchange” currency options, and have since begun to offer a much wider range of products, which in turn have helped to make the market far more liquid.  We  will take a look at some of these in more detail, over the next few pages.

Exotic currency options, are growing in popularity, fuelled by the boom in the forex retail market which allows small traders to speculate on currency price movements using very small lot sizes and huge leverage. The market is unregulated as none of the trades are quoted on listed exchanges, but are simply OTC trades offered by inter market brokers, and based on the underlying prices of the  inter bank rates. Now, you will probably come across a wide range of terms for these currency options which is one of the reasons it is so confusing for new traders – these include, but are not limited to : binary currency options, digital currency options, and many more. As far as I am concerned all these types of currency option can be classed as one type – the SPOT currency option.

SPOT stands for Single Payment Option Trading, and effectively describes in simple terms, how the option works in principle. At its simplest level a trader imagines a future movement in an exchange rate between a currency pair, and in a given time frame. The premium required will depend on the likelihood of the event occurring – the higher this is then the greater the premium and visa versa. A contract price is set should the event occur. If the event occurs then the trader will win the agreed amount, and if the event does not occur, then the trader simply loses the premium. The beauty of SPOT options is in their simplicity,  both to implement and execute, but whilst they have certain advantages, there are also disadvantages which you need to consider, before being seduced by their simplicity!

I hope that has explained the currency options market in simple terms – I cannot stress enough that it is very confusing as exotic options have so many names and terms – and there is even an overlap into fixed odds betting which I will explain shortly – now let’s look at some of the vanilla currency options for trading, the advantages, disadvantages and the ease of trading.