Currency Option: Definition, Types, Features and When to Exercise

For example, you would buy a GBP/USD call option if you thought GBP would rise in value against USD. Your potential profit would be unlimited in this case, and your losses would be limited to your options premium. If you choose to speculate on the price of an options contract with spread bets and CFDs, you’ll be trading with leverage.

CFD trading is available in jurisdictions in which CMC Markets is registered or exempt from registration, and, in the province of Alberta is available to Accredited Investors only. CMC Markets is an execution only dealer and does not provide investment advice or recommendations regarding the purchase or sale of any CFD. CMC Markets is remunerated through the spread which is the difference between the bid and ask price.

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The underlying market price must move through the strike price to make it possible for that option to be executed – known as in the money. If this doesn’t happen, the option will expire worthless – known as out of the money. Hedging with options involves opening a position that will offset risk to an existing trade, such as an open spot forex position. For example, an FX put option is a popular method of protecting yourself against the depreciation of a currency. In this instance, you’d open an option with a strike price below the current market level, and if the market moves below that put option price, you’d profit from the decline.

1. Our Next Generation trading platform combines institutional-grade features and security, with lightning-fast execution and best-in-class insight and analysis.
2. Finally, note that the line extending from the kink at the strike price continues in an unlimited fashion as the EUR/USD spot rate rises at expiration.
3. Most investors are familiar with stock or equity options, however, there are options available to the retail forex currency trader as well.
4. The first of these spread trades is the debit spread, also known as the bull call or bear put.
5. IG International Limited is licensed to conduct investment business and digital asset business by the Bermuda Monetary Authority.

There are two primary types of options available to retail forex traders for currency option trading. Currency options – or forex options – give the holder the right, but not the obligation, to buy or sell a currency pair at a given price before or on a set expiry date. For example, if you were buying EUR/USD​ but you thought there might be a short-term decline in the price, you could also buy a euro put option to profit from the decline while maintaining your buy. FX options are also available through regulated exchanges which are options on FX futures, in which case it is simply a call or a put. These offer a multitude of expirations and quoting options with standardised maturities.

CMC Markets Canada Inc. is a member of the Canadian Investment Regulatory Organization (CIRO) and a member of the Canadian Investor Protection Fund. CFDs are distributed in Canada by CMC Markets Canada Inc. acting as principal. Trading CFDs involve a high degree of risk and investors should be prepared for the risk of losing their entire investment and further amounts.

The Debit Spread Trade

Spread strategies that are used in equity options can also be used with FX options, including vertical spreads, straddles, condors and butterflies. For those that prefer the relative pricing transparency of transacting derivatives via an exchange, several major exchanges provide liquidity in moderate dealing amounts for traders to execute currency option transactions. If that is not the case, it is typically more advantageous to simply sell back such American Style options to capture both the time and intrinsic value, rather than to exercise them early and lose all of the remaining time value as a result.

Furthermore, the slope of this increase will depend on the size of the position taken. The second part of an option’s price is known as extrinsic value, and it comprises all the remaining portion of the option’s current market price. Options that have a high implied volatility, a long time remaining until expiration and strike prices situated at the money tend to have the highest extrinsic value. The time component of extrinsic value is often referred to as time value. In order to execute a transaction, the amount of one currency will need to be specified to the market maker.

The call gives the buyer the right to purchase a currency pair at a given exchange rate at some time in the future. The put option gives the buyer the right to sell a currency pair at a given exchange rate at some time in the future. Both the put and call options give investors a right to buy or sell, but there is no obligation. If the current exchange rate puts the options out of the money, then the options will expire worthlessly. Options are available for trading in almost every type of investment that trades in a market.

Most investors are familiar with stock or equity options, however, there are options available to the retail forex currency trader as well. Spread bets and CFDs are kraken trading review complex instruments and come with a high risk of losing money rapidly due to leverage. 71% of retail investor accounts lose money when spread betting and/or trading CFDs with this provider. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money. In practice, this means that American Style forex options are generally similar in price to but no cheaper than European Style options. When combining traditional positions with a forex option, hedging strategies can be used to minimize the risk of loss.

How To Use FX Options In Forex Trading

You’d buy a forex put option if you thought the quote currency will strengthen against the base currency before expiry. For example, you would buy a GBP/USD put option if fusion markets review you thought USD would rise in value against GBP. Again, your potential profit would be unlimited in this case, and your losses would be limited to your options premium. You’d buy a forex call option if you thought the base currency will strengthen against the quote currency before the expiry date.

An example of the IG options deal ticket can be seen below, with different columns for buying or selling call and put options. There is more information about the mechanics of buying or selling call and put options below. Placing an outright or naked option position is one of the easiest strategies when it comes to FX options. American Style options on the higher interest rate currency tend to have a slightly higher time value than the otherwise identical European Style options, as the following section will explain in greater detail. The straddle is a bit simpler to set up compared to credit or debit spread trades. In a straddle, the trader knows that a breakout is imminent, but the direction is unclear.

What is CFD trading?

Or, they can also be used to speculate on long- or short-term market views rather than trading in the currency spot market. Options prices are derived from the base currency, which is the first currency in the currency pair (eg euros in EUR/USD). If you are bullish on the base currency then you should buy calls or sell puts, conversely if you are bearish you should buy puts or sell calls. The American-style option can be exercised at the strike price, any time before the expiry date. The currency option market even has its own over the counter brokers that are distinct from the typical forex market brokers. The FX Options market produces a large daily turnover making it one of the most liquid derivatives markets in the world.

The risks of loss from investing in CFDs can be substantial and the value of your investments may fluctuate. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how this product works, and whether you can afford to take the high risk of losing your money. Buying forex puts or calls comes with lower risk than spot forex trading or FX forwards, because you can only lose your initial option premium (margin) if the trade doesn’t go your way.

If the current exchange rate puts the options out of the money (OTM), then they will expire worthlessly. Because of the risk of loss when writing options, most retail forex brokers do not allow traders to sell options contracts without high levels of capital for protection. Options traded in the forex marketplace differ from those in other markets in that they allow traders to trade without taking actual delivery of the asset. Forex options trade over-the-counter (OTC), and traders can choose prices and expiration dates which suit their hedging or profit strategy needs.