Congratulations! You have decided to learn about options. This may be your first lesson ever or a refresher course, but our goal is to make learning options interesting and easy.
Did you know options are another way to trade the markets but they empower a trader to create new strategies to do a lot more than follow price direction?
What is an option?
An option is a contract sold by one party (the writer) to another party (the holder). The contract offers the buyer the right, but not the obligation, to buy or sell a financial asset at an agreed upon price in the future. The financial asset in our case is the currency or commodity.
Option contracts can be described as an insurance policy to insure the price of a financial asset and, similar to an insurance policy, the buyer has to pay the seller a premium. Premium is the value of an option contract.
Companies, in which you purchase products from, are trading options to hedge their costs, e.g. Jewellers have to purchase gold often and they may secure future prices, eliminating risk, by buying options.
How can buying an option help a jeweller limit risk? An option is a financial contract giving the buyer the right but not the obligation to buy gold at an agreed price over a certain period of time. For example, the jeweller could have bought an option contract last month giving him the right to buy 10 oz of gold at $1210 for one month.
Exercising an option means you are putting into effect the right of the contract. The jeweller has the right, but is not obliged, to exercise his option. Hence, if the price of gold rises, he will exercise the option to buy gold at a lower price. Conversely, if the price of gold falls, he will not exercise his option since he is able to buy at a cheaper price in the market. Either way the jeweller is getting the best price!
You could view buying an option as a form of insurance; the option contract is insuring a gold price. You have to pay for the contract; the amount you pay is called the Premium.
The amount of Premium will depend on the amount of gold and the price you want to insure as well as the duration of the contract. Option contracts, which insure for a better price and a larger amount of gold over a longer period of time, cost more.
The Premium will also depend on other factors, such as volatility in the market. For example, if the gold price is expected to be volatile over the duration of the contract, then the premium will be higher.
The above example uses a tangible asset and it is much easier to imagine buying and selling physical assets. When you transcend to Over-the-Counter trading (electronic trading), you will be trading intangible assets since you will never actually receive the goods you are buying or selling.
If you are wondering if you can just simply buy and sell options to make money, yes you can! Our lessons start by teaching you the most simple buy strategies to trade market movements.
Many people think of the stock market when they think of options. However, the foreign exchange market also offers the opportunity to trade forex options and our lessons will focus mostly on these unique derivatives. Since forex options are traded over-the-counter (OTC), traders can choose the specific market rate and date on which an option is to be valid, then receive a quote stating the premium they must pay to obtain the option.
Why trade options?
You may be wondering, “Why trade an option and not the underlying asset?” Good question, because…
- When buying an option, your downside risk is limited to the option premium (the amount you paid to purchase the option).
- When buying an option, you have unlimited profit potential.
- You can pay less money up front than for a forex position.
- You can build strategies to trade many different market outlooks, such as a strategy profiting from a move in either direction.
- Options can be used to insure an open forex deal (or a portfolio of deals), to trap profit, and/or limit risk.
So now that you know what an option is, our next lesson will begin to explain the building blocks of an option.
The content provided is made available to you by ORE Tech Ltd for educational purposes only, and does not constitute any recommendation and/or proposal regarding the performance and/or avoidance of any transaction (whether financial or not), and does not provide or intend to provide any basis of assumption and/or reliance to any such transaction.
Editors’ Picks
EUR/USD climbs to daily highs near 1.1820
EUR/USD now picks up pace and advances to the area of daily peaks north of the 1.1800 barrier at the end of the week. The pair’s decent move higher comes against the backdrop of a generalised lack of direction in the FX galaxy and the mild offered stance in the US Dollar.
GBP/USD trims losses, retests 1.3460
After briefly challenging its key 200-day SMA near 1.3440, GBP/USD now manages to regain some balance and revisit the 1.3460 zone on Friday. Cable’s pullback comes as the selling pressure on the Greenback gathers traction, reigniting some recovery in the risk-linked space.
Japanese Yen gives back half of early gains against USD ahead of US PPI data
The Japanese Yen (JPY) surrenders half of its early gains against the US Dollar (USD) during the European trading session on Friday. The USD/JPY pair rebounds to near 155.90 as the JPY falls back, but is still 0.15% down.
Editors’ Picks
EUR/USD: Fed calm, ECB steady, but the Dollar still leads Premium
EUR/USD is still struggling to find real traction. The pair has tried to stabilise, but momentum keeps fading, leaving the door open to further weakness.
Gold: Falling US yields, geopolitics help XAU/USD hold ground Premium
Gold (XAU/USD) gained traction and climbed above $5,200, ending the fourth consecutive week in positive territory. The next round of US-Iran talks and crucial macroeconomic data releases from the US will be watched closely by market participants in the short term.
GBP/USD: Will Pound Sterling defend key 1.3450 support ahead of US jobs data? Premium
The Pound Sterling (GBP) entered a bearish consolidation phase against the US Dollar (USD), after having tested critical support near the 1.3450 level on several occasions.
Bitcoin: Another month of losses, and it’s been five
Bitcoin (BTC) price is stabilizing around $68,000 at the time of writing on Friday, but the Crypto King is poised to close February on a fragile footing, marking its fifth consecutive month of losses since October and a rare start to the year with back-to-back monthly corrections.
US Dollar: At a crossroads; Fed steady, tariffs in flux Premium
The US Dollar’s (USD) upward momentum from the previous week seems to have encountered a tough nut to crack in the 98.00 region, as measured by the US Dollar Index (DXY).
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