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 looks offered below 1.1900
EUR/USD keeps its bearish tone unchanged ahead of the opening bell in Asia, returning to the sub-1.1900 region following a firmer tone in the US Dollar. Indeed, the pair reverses two consecutive daily gains amid steady caution ahead of Wednesday’s key US Nonfarm Payrolls release.
GBP/USD slips back to daily lows near 1.3640
GBP/USD drops to daily lows near 1.3640 as sellers push harder and the Greenback extends its rebound in the latter part of Tuesday’s session. Looking ahead, the combination of key US releases, including NFP and CPI, alongside important UK data, should keep the pound firmly in focus over the coming days.
USD/JPY drops toward 155.00 as focus shifts to US data
USD/JPY meets fresh supply and inches closer toward 155.00 in the Asian session on Tuesday. The Japanese Yen holds the upper hand over the US Dollar after Japanese Prime Minister Sanae Takaichi led the ruling Liberal Democratic Party to a historic landslide win and on intervention talks. Traders brace for key US economic data that could offer more clues on the Federal Reserve's monetary policy.
Editors’ Picks
AUD/USD meets initial resistance around 0.7100
A decent rebound in the US Dollar is behind the AUD/USD’s daily pullback on Tuesday. In fact, the pair comes under modest downside pressure soon after hitting fresh yearly peaks in levels just shy of 0.7100 the figure on Monday. Moving forward, investors are expected to closely follow the release of Chinese inflation data on Wednesday.
EUR/USD looks offered below 1.1900
EUR/USD keeps its bearish tone unchanged ahead of the opening bell in Asia, returning to the sub-1.1900 region following a firmer tone in the US Dollar. Indeed, the pair reverses two consecutive daily gains amid steady caution ahead of Wednesday’s key US Nonfarm Payrolls release.
Gold the battle of wills continues with bulls not ready to give up
Gold remains on the defensive and approaches the key $5,000 region per troy ounce on Tuesday, giving back part of its recent two day. The precious metal’s pullback unfolds against a firmer tone in the US Dollar, declining US Treasury yields and steady caution ahead of upcoming key US data releases.
Bitcoin's downtrend caused by ETF redemptions and AI rotation: Wintermute
Bitcoin's (BTC) fall from grace since the October 10 leverage flush has been spearheaded by sustained ETF outflows and a rotation into the AI narrative, according to Wintermute.
Dollar drops and stocks rally: The week of reckoning for US economic data
Following a sizeable move lower in US technology Stocks last week, we have witnessed a meaningful recovery unfold. The USD Index is in a concerning position; the monthly price continues to hold the south channel support.
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