Forex Options

By: EconomyWatch   Date: 28 July 2009

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Forex options are contracts between a buyer and a seller where the buyer has the special power of buying or selling forex at a predefined rate and on a specified time. In lieu of this power, the buyer pays the seller a premium. Forex options are derivative contracts, which mean that the price of the contract is derived from the underlying assets (forex).

 

Difference between Forex Futures and Forex Options

 

Forex futures and options are both contractual investments in the forex market. However, they are not synonymous. The fundamental differences are:

  • In futures, both the parties have to abide by the contract whereas in forex options only the seller has to abide by it.

  • In futures, there is no contract premium. The only cost is the contract’s price whereas in forex options, the buyer pays a premium to get into the contract.

Advantages of the Forex Options

The high liquidity of the forex market has resulted in many innovative styles of trading. The success of these experiments has been helped by the many advantages they offered. Advantages of forex options are:

  • Flexibility. Forex options can be tailor made to suit your strategies. They can have reliable or high risk currencies as their underlying assets. With customizability, they offer more control over the trading style.

  • Leverage: A buyer is offered leverage without any commitments to any trade. This lets many avoid heavy losses.

  • Limited Risk: With smaller option premiums, the risk is limited.

  • Hedging: Forex options lets traders diversify and protect themselves against price movements.

Disadvantages of the Forex Options

Like all other financial investment, there are a few disadvantages as well:

  • Liquidity: A trader with high risk currencies might suffer from low demand as there are other attractive options available in the market.

  • Complexity. Forex options can confuse even an experienced trader with their complexities. They require a lot of observation and maintenance.

  • Time delay: Many deals do not mature as the prices do not match with the expectations of the buyers.

On a holistic level, the forex options present profitable opportunities for those who can take advantage of the volatility and the liquidity of the forex market. If a trader is not sure about options, it is advisable to stick to forex spot.


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