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Investing in Forex Options

31 January 2012

Presented by: Zoe Fiddes

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easy-forex® endorses responsible and moderate trading. Options relating to forex trading (OTC Trading) involves substantial risk of loss up to your invested capital, and may not be suitable for everyone and we would like to recommend you not to risk any money that you cannot afford to lose. Please note that the information and content provided in our workshops and/or seminars is made available for informative and educational purposes only and can under no circumstances be considered as a recommendation to you by easy-forex® or any easy-forex® personnel to engage in any trade. Hence, neither easy-forex® nor any of its personnel can under any circumstances be held responsible for any outcome of trading decisions or trades in regard to any of these workshops and/or seminars.

Easy Forex Trading Ltd

Regulated by the Cyprus Securities and Exchange Commission CySEC License Number 079/07

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Investing in Forex Options This is a product that gives you the ‘right’ to execute a buy or a sell trade at a price that you have chosen, but you are not obliged to do this.

For example, let’s say the spot price of EURUSD is 1.3100 and I get an option with the ‘right to buy’ it at 1.3200 with expiry in 7 days. Note that we call 1.3200 the ‘strike’.

If the market moves to 1.3300 before the expiry date then I would be ‘in the money’ as I have the right buy 100 pips lower than the spot price.

In the same way I could have bought an option with the ‘right to sell’ if I expect the price to fall before the expiry date.

1.3200

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Cost of an Option You have to pay for an option upfront.

This fee is called the premium

You can close the option at any time before expiry; you will only do this if the option has made you money.

The option will be in profit when the live premium is greater than the premium you paid, i.e. you can sell the option for more money than you paid for it.

P&L = Live premium of open option – Premium you paid initially

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Option Price

Intrinsic Value

TimeValue

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When the strike is preferential over the spot rate the option is ‘in the money’ (ITM)

For example, if my strike to buy is 1.3200 but the spot rate is 1.3300.

Intrinsic value = 0, until the option is ITM.

Intrinsic Value

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Made up of several components but primarily volatility and time to expiry More volatility = higher

time value

Longer time to expiry = higher time value

At expiry, time value = 0

TimeValue

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Profiting from an OptionAim: to buy an option at one premium and sell it later at a higher premium either before the expiry or at expiry. Any profit will be transferred into your account automatically.

How can the premium of your open option be higher than premium you paid?

If the spot moves in your favour (intrinsic value increases)

If volatility increases (time value increases)

Unlike normal spot trading you do not only profit from the move - you can also profit from the volatility!

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Increase in Intrinsic Value before Expiry right-to-buy example

Option with ‘right-to-buy’ €100K EURUSD at 1.3200, 7-day expiry

Spot rate at open = 1.3100. Premium = $400 (time value only)

With 6 days to expiry, spot has moved to 1.3300 => 100 pips ‘in-the-money’ => Premium = $1330 ($1000 intrinsic value + $330 time value)

Sell the option back => Overall profit = $1330 - $400 = $930

Notice that time value has decreased as the option’s validity is 1 day less.

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Increase in Intrinsic Value at Expiry right-to-buy exampleOption with ‘right-to-buy’ €100K EURUSD at 1.3200, 7-day expirySpot rate at open = 1.3100. Premium = $400

At expiry, spot is at 1.3300 => 100 pips ‘in-the-money’ => $1000 profitOverall profit = $1000 - $400 = $600 (intrinsic value only)

Spot rate at expiry

Premium at expiry

Premium Paid

P&L at expiry

1.3100 0 $400 - $400

1.3150 0 $400 - $400

1.3200 0 $400 - $400

1.3250 $500 $400 + $100

1.3300 $1000 $400 + $600

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‘Right-to-buy’ example – Call Optionvalue of option at expiry

1.29 1.3 1.31 1.32 1.33 1.34 1.35

-1000

-500

0

500

1000

1500

2000

2500

P&L ($)

P&L ($)

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1.29 1.3 1.31 1.32 1.33 1.34 1.35

-1000

-500

0

500

1000

1500

2000

2500

P&L ($)

P&L ($)

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‘Right-to-sell’ example – Put Optionvalue of option at expiry

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JargonCall = right-to-buyPut = right-to-sell

Strike = execution ratePremium = price of the optionIntrinsic value = the amount by which the option is in the moneyTime value = Price (value) of the option less its intrinsic value

OTM = Out of the moneyATM = At the moneyITM = In the money

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Why Trade Options?Options are very versatile and can be used in many ways.

Speculation You can speculate on the future exchange rate or price volatility

Insurance & HedgingOptions are one of the best ways for a business or individual to protect themselves against exchange rate risks. Insure/hedge an existing open forex deal against a loss Insure/hedge the cost of an upcoming trip abroad Insure/hedge a companies international trading (profits are protected from an unfavourable move) Insure/hedge a foreign currency loan

Professional strategies to suit advanced traders

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Building StrategiesStrategies involve trading a number of options at once as part of a single trade. This opens the door to dynamic trading.

The Long StraddleAn option where you buy a call and a put at the same time. This enables you to profit from a move up or a move down.

For example, you buy a call with strike 1.3200 for €100K EURUSD and at the same time you buy a put with the same strike and size. Say the premium is $650 for each, hence total price is $1300.

Your call will be ITM if the spot price goes above 1.3200 and your put will be ITM if it goes below 1.3200.

But you need to make your cost back first.

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The Long StraddleHere are the scenarios of cash flow based on intrinsic value at option expiry

Spot rate at expiry

Call Premium

Put Premium

Total Premium at expiry

1.2900 0 $3000 $3000

1.3000 0 $2000 $2000

1.3100 0 $1000 $1000

1.3200 0 0 0

1.3300 $1000 0 $1000

1.3400 $2000 0 $2000

1.3500 $3000 0 $3000

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The Long StraddleNow if we include the price we paid for the option strategy

Spot Price Premium at expiry

Premium paid

P&L

1.2900 $3000 $1300 $1700

1.3000 $2000 $1300 $700

1.3100 $1000 $1300 -$300

1.3200 0 $1300 -$1300

1.3300 $1000 $1300 -$300

1.3400 $2000 $1300 $700

1.3500 $3000 $1300 $1700

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The Long Straddle – price at expiry

1.28 1.29 1.3 1.31 1.32 1.33 1.34 1.35 1.36

-1500

-1000

-500

0

500

1000

1500

2000

P&L ($)

P&L ($)

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Conclusion

A new way to trade with more choices Cannot get stopped out Exchange rate insurance Loss is capped whilst profit potential is unlimited Great chance to try something new Copy strategies in the strategies marketplace

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Your first options trade is risk free up to £100*

Register by 2 Feb. and complete a trade by 8 Feb.

Step into the future of trading – trade forex options today

*Terms and conditions apply

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Questions?

Step into the future of trading – trade forex options today