Forex Trading Library

How to Use Options for Forex Trading

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Options trading is a really popular alternative to trading most equities classes. But they are virtually non-existent among retail forex brokers. Forex options do exist, of course; but generally, you have to go to a bank or major trading house to have access to them.

If options are such a widespread class, why aren’t brokers interested in making the service available to traders?

Well, it turns out that when trading CFDs, you can get most of the advantages of options without the extra cost.

What are Forex Options?

Forex options are just the currency version of options, and function in the same way. Basically, an option gives you the “option” to buy or sell an asset for a certain amount of time at a particular price.

In order to do this, you have to pay a premium to the seller (the “writer” in the technical parlance).

How Does it Work?

For example, let us say that you think EURUSD is going to go up at some point. You don’t know exactly when, but sometime today. So, you could buy an option at the current price for 24 hours.

Then, if EURUSD goes up during that time, you can exercise the option; buy at the lower price and sell at the higher one. The potential upside is theoretically limitless (within the reality of how much the currency moves during that period of time).

Is it Really Win-Win?

But, if the market doesn’t go up, and instead the EURUSD crashes, you could just let the option expire. It doesn’t matter how far the currency goes down, you simply don’t buy it. All you end up paying is the premium.

The potential upside, and why options are popular for hedging, is that you can limit your losses to the premium.

Although it sounds like you could make more than you lose, you should consider the other side of the trade. In this case, whoever is writing the options is going to charge a premium that balances out their risk as well.

So, Why Aren’t Forex Options Easily Available?

The other main advantage of options when trading other asset classes is that you don’t have to take delivery of the asset. This means that brokers are able to sell options without a commission. If you were to buy stock, the commissions can be very expensive. But, with options, all you pay is the premium.

However, when trading CFDs, you already don’t pay a commission. And CFDs generally have narrower spreads than the premiums offered by options brokers. What this means is that if you believe EURUSD is going to go up, you could just buy the pair and put in a stop loss.

Basically, you could have all the main advantages of an option without having to get a special options account. Furthermore, if you have a reliable and responsible broker, it often works out to be cheaper.

For people who trade larger sums of money, there are still some extra advantages to trading forex options. This explains why they exist for corporate traders. Furthermore, there are some interesting options strategies that have applicability when trading forex CFDs.

But the simple answer to how to trade options in forex is through CFDs.

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