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Exotic Currency Options

Exotic currency options in essence are OTC trades, or over the counter products –  in other words they are neither traded nor offered through a central exchange. Instead, they are products designed and offered by the brokers themselves, and are often referred to as SPOT option, and a products much more akin to the spot forex market which we all know and love!

Now with SPOT options we start to blur the edges a little of where option trading ends, and fixed odds trading or betting begins. SPOT options are generally not offered on line, although this trend is already starting to change as forex brokers begin to realise the opportunities available and start to offer one or two ‘standard’ exotic options. More likely is the fact that you will probably have to call your broker for a price on a particular SPOT option strategy. Let’s have a look at a simple example of one of the most popular exotics,  called a ‘one touch’ option, which I hope will make the point. This option becomes profitable ( or wins if you like )  if the price of the currency pair touches a specified price within a specified time.

Suppose the EUR/USD pair is trading at 1.4900 and we are bullish, believing that Euro strength will continue against the US dollar and that 1.5000 seems a likely target in the next few days. In this case we could buy a 1.5000 one touch option expiring in three days time. The premium for this option might be $45 and if the price reached 1.5000 and touched in the next three days, then we might receive $100. If the pair did not touch the price, then we would lose all our premium. Timing is  critical with exotic options. You must know the exact time of expiration, and each broker may have different cut off conventions. Typically, exotic options are timed against the New York cut off, which is 10 a.m. ET. However, some brokers will set the cut off time at 24:00 GMT (4 a.m. ET), so you will need to confirm the time convention before making the trade. Now, unlike plain vanilla options, which have single strike prices and standard expiry dates which are known and published ( e.g. an MCD 50 call expiring on the third Friday of the following month) , exotic options incorporate conditional scenarios based on both price and time. The most common exotic options are as follows :

  • One touch – as explained above, a simple price touch will trigger the option
  • No touch – here we are looking for the currency pair not to touch the strike price during the option life
  • Double one-touch – this is also known as the barrier option. Two strike price barriers are selected and payout occurs if either one is touched. This is similar to a standard long strangle or straddle, where we expect volatility to enter the market and prices to move significantly, but are not sure which direction the market will move. The option closes worthless if no touch occurs on either strikes.
  • Double no touch – the opposite of the double one-touch as we are looking for a sideways trending market which is range bound and with low volatility for the duration of the trade.
  • Digital options – in some ways the opposite to the above as a digital option will only be profitable if the condition is met on the day of expiry. In other words the strike price might be met during the life of the option, but if it is not met on the day of expiry ( even by one pip ) then the trade will lose.

OK – now we understand a little more about the main types of currency options available, one has to ask the question ” why trade options ” – after all we already have the spot currency market which allows us to trade very easily in the currency of our choice, both long and short. Indeed based on the current products available, we have a much greater choice of currency pairs to trade in the spot market, than in the options market. Let’s consider some of the pros and cons for both vanilla and exotic options, and then we’ll go on to look at using currency options in some trading strategies.