What are Forex Options?
One of the common terms you will encounter when transacting or trading in the forex market is forex options. The good news is that these tools can help you secure the best exchange rates. However, it’s essential to understand how they work on forex markets.
Forex options are derivative financial instruments that give you the right, but not the obligation, to exchange currencies at a specific date (expiry) and an agreed rate (strike price). People mostly choose forex options because it is less risky when buying.
What You Should Know About Forex Options
As the trader, you will sign Forex option (often abbreviated as FX) contracts over-the-counter, and they are fully customizable. However, it is also essential to know that these contracts expire at any time, after which you cannot sell the currency.
Currency options are of two types; puts and calls. A call option makes it possible for you to buy a currency, and you need the put options to sell it. The options are valid until the expiry date, and if you are not sure about the trade, you can withdraw your options.
With FX options, the trade currency is quoted in pairs. An example is EUR/USD. Thus, the first currency, the EUR, is the base currency, while the USD is the quote currency.
You can buy forex options through regulated exchanges. These have many expirations and standardized maturities on the quoting options. Trading these forex options on a forex market gives you ten currency pairs of FX options involving the US dollar.
Advantages of Trading with FX Options
A significant advantage of FX options is that they are less risky when buying. For example, suppose you buy a EUR/USD, and before selling, you realize that USD prices are lower, which could lead to losses. In that case, you can purchase the euros.
You can hedge other positions with the FX option. This involves using different market strategies to offset the risk that an existing trade can face.
For example, when opening a ‘put’ option, you can go for an option whose strike price is below the market level. This protects you from losses because if the prices go below the put option price, you will profit from the decline.
Binary Options Forex Trading
The foreign currency market has an alternative tool for forex traders, which are binary options. Some people prefer binary options because they have limited potential losses. With them, the trader can tell when a loss is likely to occur in advance.
So, what is binary options trading in forex? Simply put, they are financial instruments whose payout depends on the underlying market conditions. If the market moves beyond the strike price, the trader gets a fixed payout.
With the help of binary options, traders can predict the outcome of the underlying market movement, which reduces the chances of suffering losses. Binary options work under three elements; the underlying market, the strike price, and expiry date and time.
The underlying market is the market you choose to trade. A strike price is a price you will sell the currency with. In binary options, you decide the strike price during the decision-making process. Do you speculate the prices to be below or above the strike?
The expiry time is the time and date after which you cannot trade a binary option. For example, there are trade binaries whose expiry date is a week and others with a short duration of even five minutes.
Binary options are accessible to retail traders and are legal to trade with regulated providers like Knightsbridge FX. However, you should ensure the exchange you are using has a CFTC regulation. This protects you from unethical market practices.
Although people claim that they are safer ways of forex trading, binary options can be risky. You will be at more risk of fraud if you trade with an exchange not regulated by CFCT. Also, always ensure you sell on your account and don’t use a broker.
How Binary Traders Make Profits
Binary forex traders make money when they correctly predict the market price position at a specific time. For example, the trader could indicate that the market will be above a particular price at a specific time. When the trade reaches its expiry time and date, you will either lose the money you invested or make a profit.
The prices of binary options are between $0 and $100. With each contract, you will see the profit you will likely gain if the prediction is correct or the maximum loss you’ll incur if the forecast is incorrect.
So, if the prediction is successful, you will get a payout of $100. Then, you subtract the amount you paid at the start of the trade from the $100 payout to know your profit.
If the trade does not succeed, you will not get any payout. However, you will only lose the capital and nothing extra because the risks are capped.
Difference Between Binary Options And Other Options
Many traders prefer binary options because the contracts have limited risks. There are also two possible outcomes when the trade expires; you can make a profit if your predictions are correct or a loss if not.
The only money you may lose is the amount you paid to open the trade. While other options have the payout depending on the difference in the strike price and the underlying market, binary options have a fixed payout.
It is easy to predict the outcome of a binary option, unlike the complexity and difficulty in pricing the other forex options.
When you decide to go for binary options for foreign exchange, first start with a demo account. This is an excellent way to learn and practice before you trade with actual money. It also builds your confidence in trading, reducing the chances of losses.
Forex trading enables traders to hypothesize on currencies without owning physical assets. There are many forex trading options, but most people go for forex options because they are less risky when buying.