FX Currency Exchange - options volatility

July 3rd, 2009 by admin

A problem that newbie options trader’s face is taming the volatility in options.

Volatility - Part of the price of the option contract is due to the volatility of the contract. The more volatile a currency, the more likely a “wild swing” could make it to the strike price and well past it. So that option will be more expensive. While this increases the contract’s price, you need volatility to increase the likelihood that you will far surpass the strike price before expiration (hopefully well before expiration).

Now, here’s a trick to help catch the volatility at just the right time. This trick will help you jump into an option trade when the option contract’s price is skewed in your favor AND to buy your option in a timely fashion.

Let’s go back to our British pound example for a second. You see, if you’re buying a call option on the pound, then you believe the pound will go upward in price (and hopefully relatively quickly). If you bought a put, then you think that the British pound’s price is too high and you believe it will come down in price.

So here’s a key to help judge the volatility and timing all in one simple indicator. It’s called “Bollinger Bands.”

Check out the chart below and I’ll show you what I mean. I’ve charted an option on a currency exchange traded fund below or ETF. (NYSE: FXE)

Bollinger Bands: Your Edge in Options Trading 



fxud 070309 image1 FX Currency Exchange options volatility

You see, as a currency goes up in value, the option’s price becomes more expensive (quickly).

So in a perfect situation: You wait for an extreme sell-off in your currency, and then buy the option extremely cheap just before the currency bounces higher. Then you sit back and wait for the explosion upward as the currency continues to sail in the right direction.

We can see that FXE is headed upward overall (as shown by the green arrow). So what we want is an unusually quick pullback that presents a rare opportunity in the price. You want to buy when it’s low but when it won’t stay low for very long.

That’s the best time to buy a call.

 

By Sean Hyman - worldcurrencywatch.com

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Posted in Currency Markets, Currency Values, Fx Forex
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