Forex Trading Strategies - currency options
Forex Trading Strategies - currency options: If you know currency options, you know there are two basic ways to place an options trade. You decide if a specific currency is going to rise, so you buy a call option on that currency on the Philadelphia Stock Exchange (NASDAQ OMX). If you believe a currency is going to drop in value, you buy a put option on that specific currency so you profit as the currency falls.
Long-term, buy-and-hold investors love currency options because it’s the one of the few ways you can shoot for triple-digit gains in currencies without playing the Forex market. In other words, you can hold currency trades for longer (anywhere from several weeks to several months), and still use leverage to earn higher returns.
Also, as an extra bonus, you strictly limit your risk because you only pay the premium for your option contract. If you choose the wrong option, your option simply expires worthless and you can only ever lose the amount you paid for that option in the first place.
How to Play Currencies With No Clear Direction
A good deal for the most part.
But what about when you can’t decide if a currency is going to rise or fall? There are plenty of times in the currency market when it’s hard to tell if a currency is about rise or fall. So it can be difficult to make a long-term “bearish” or “bullish” prediction with options.
For example, I told you on Friday how the euro looks to sink by New Years, but has the opportunity to rally in the short-term. In other words, I’m both bullish short-term on the euro and bearish in the longer-term.
Similarly, as I mentioned on Thursday, I’m waiting for some clarity to see how this British pound story plays out because right now, there’s a 50/50 split of bearish and bullish traders for the pound.
So what do you do in these bearish/bullish instances? Well, there are a couple options trading strategies you can use to play both sides…
Grab Profits While You Sit on the Fence with These Two Strategies
A “straddle” actually involves buying two options contracts. Like the name implies, you use this strategy when you’re sitting on the fence about a currency. You believe it’s about to make a large move one-way or the other but you have no idea which.
To qualify as a straddle, both options trades must have the same expiration date, underlying currency and strike price.
The point of the strategy is to protect you when you see no clear direction in the currency markets. You don’t make as high returns as you would off a straight put or call option, but you don’t lose as much.
In fact, that’s why straddles are known as “volatility strategies” because they hedge your position just in case the markets swing in the other direction.
Here’s how a straddle works…
Let’s go back to the example above for a second with the British pound. At the moment, there’s no clear-cut direction of where it’s heading. But let’s say you believe the pound could break out either higher or lower soon.
So you could buy both a put and call option on the British pound with the same strike price, and expiration date, to hedge your position.
However, this is where it gets dicey: To profit on a straddle you need to make sure that your underlying currency is about to make a large move. If your currency continues to range-trade, then you’ll lose. In other words, a straddle isn’t worth your time (or money) if you don’t see a large move coming.
Straddle’s Twin Brother…
There’s another paired option-trading strategy, known as “a strangle.”
It’s VERY similar to a straddle. In fact, it’s almost like a twin version of a straddle with a few key differences. Like a straddle, the strangle involves buying both a call and a put option on the same underlying currency.
Again, like a straddle, you use a strangle when you see a major breakout coming in a particular currency. To do so, you also choose two option contracts that have the same expiration date.
The major difference between these two: They have different strike prices.
As a general rule, you would use straddles when you are expecting a big move but are not sure of the direction. You would use a strangle if we have a bias as to the possible direction of the move, but want to protect yourself in case you’re wrong. Traders tend to like strangles because they can be a bit cheaper than your normal straddle.
To recap: Different technique, similar repercussions.
What can we takeaway from this? First of all, there’s a LOT more to trading options than just your normal calls and puts. Secondly, there are still ways to make money in currencies even when you don’t see a clear direction forming in a specific currency.
Bottom line: You don’t need to be a top-notch trader and have a crystal ball to make money in currencies. You can bet on a currency even if you’re completely stumped about which way it will sail next.
By Ashish Advani - www.worldcurrencywatch.com
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