The Basics of Forex Currency Options?
Most investors understand limits vs. market orders, a good investor also knows terms like moving average and pivot points and support and resistance. Many traders learn the basics and leave it there and start to trade the markets. Successful and profitable currency and forex traders don't stop at the basics. They want to make as much profit as possible with the least amount of risk. They want to make the best trades possible and make the most of our each trade. Successful investors learn and learn more. They keep developing strategies and testing these strategies, they learn the pulse of the markets and they search long and hard to find new sources of data and information.
So the question begs to be asked. Why don't good traders learn to buy protection through the options markets?
There are lots of terms like strike price, premium, expiration, and contracts. I assure you that trading the options markets are only as difficult as you make it. The same is true with the forex markets
Current market conditions are giving the appearance that currencies are entering a new era where their movements are closely correlated. Lately, it has been very easy to see the movement of well known currency pairs reacting to market news and data.
Forex Traders use downloadable platforms, technical analysis, and pattern recognition and automated trading systems. Clearly the masses have come a long way. The point being is, the investor chooses how complicated they want to let forex and currency get for them. This is the same for the options market.
People use options all the time in everyday life, they just don't realize it. Wikipedia defines a currency option as In finance, a foreign-exchange option (commonly shortened to just FX option or currency option) is a derivative financial instrument that gives the owner the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange on a specified date.
An option gives the holder the right to sell/buy a particular currency at a specific price by a specific time. The put guarantees the forex owner to get a certain value for their asset no matter how bad it gets drops in the market.
Let's explain it more simple terms. When you purchase insurance you are actually getting a guarantee against a disaster in the market. There is the value of the asset you are protecting like a house, a car or your life. There is the deductible, which is the amount you're willing to cover yourself in case disaster before the insurance kicks in. There is the premium you pay for the insurance. And there is the amount of time you want to be insured. All of this is easy to understand and we do it every day. (Just a quick note, you can purchase currency options to protect you from the price going up or down, these are called calls and puts)
When it comes to a protective put (the price going down, also known as short), these are the exact components you need to know, and they just have different names.
Sure there are terms that the insurance agent uses behind the scenes that you have no idea about like payout probabilities or the weighting of health risk factors. Those kinds of factors exist in the options market as well, but you just don't need to know about them unless you plan on opening up your own insurance company.
Premium: Amount you pay. When buying insurance you look to find the best rate. Usually looked at how much you pay annually in dollar amount.
Premium: Price of the option as defined by the open market. Usually looked at as a percentage of the asset you're protecting
Period: This is the time that insurance covers the holder. Usually it rolls as you regularly pay.
Time till Expiration: This is how long you have the right to sell the stock and is identified by the month of expiration.
Deductible: The amount of asset damage you pay or absorb for before the insurance kicks in.
Strike Price: This is the price you can sell your stock for. Stock price to put strike is the amount of asset decline you can take before the insurance kicks in.
Asset Value: This is how much your insurance covers. Your insurance contract defines what it covers.
Investment Value: This is value of your investment and translates to the number of contracts you buy.
In the options market there's no shopping around to pick the provider, there is a set price and one market. Or in the case of the asset being protected, insurance doesn't give the flexibility or power of choice to the holder like the options market does. Take your car, for example, as it gets older and depreciates in value, you're at the mercy of your agent to determine how much you pay.
In many ways, the protective put is easier to manage than insurance.