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Range-bound Markets Entice Option Writers: Calls to go up, Puts to go down
Over the course of the last two months the currency markets have been mired in a fairly obvious trading range. With the range being held, traders who have become adept at finding different ways of capitalizing on this scenario are becoming more comfortable trading Currency options, in addition to their spot forex trading.
Strategies being employed during these range bound periods usually involve the shorting (selling) of Options, otherwise known as the shorting or selling of volatility. The combination of option time and market volatility, or uncertainty, gives value to options with strike prices that are out-of-the-money; there is no intrinsic value in the option price, the value is all in the time until expiry.
Buyers of options are those who purchase the instrument from the ones above who are selling (or writing). In range-bound markets, that may soon break, they are usually said to be buying time at a fairly cheap price. They are anticipating a volatile move, in both the market, and then by default the option itself, and that creates an anticipation that the trading range will get broken.
Traders will also buy options to hedge their primary Spot (underlying) exposure, to replace the need for a stop loss in the cash market. The spot position is covered by the option value increasing if things move against the cash price.
The option seller wants to receive a premium for the option that they are writing, which they deem worthless as it has only time value because of being out-of-the-money, and therefore the option writer is willing to sell time, especially in a range-bound market
Current scenario: Eur/Usd
The Eur/Usd, on June 3rd 2009, made highs of 1.4340, and then followed on by making lows of 1.3750 on June 16th 2009. It has not broken either support or resistance levels since.
Prior to that, the 1.3680 resistance level was broken on May 20th 2009. This level became the support area that has since stayed intact, while the previous high above 1.4340 has not been seen since the last few days of 2008.
Option writers hope to capitalize on this range by straddling the Eur/Usd market. They would short (sell) Call options, with strike prices above the 1.4340 resistance, and short (sell) Puts with strike prices below 1.3750.
This strategy is employed with anywhere from 25-30 day expiration, where time is still valued, even with odds of these strikes being hit at, or near, a paltry 10%.
That means that there is a 90% chance that the strike prices will not be reached within 25-30 days and the seller (or writer of the option) would keep the premium received for the risk in writing the short.
A trader with confidence and conviction of calling a range bound market will take that bet more times than not, the odds are actually stacked in the option writers favor, and these ease with which options can be written, bought, and sold make for a fluid exchange, in a liquid commodity that has an exchange floor to monitor order flows and open interest.
Straddle Explanation: The channel is formed by the 1.4700 price on top, and the 1.3700 price below.
(Resistance) The 1.47 Call Option offers the right, but not the obligation, for the buyer to own a Buy position at this price
(Cash/Spot Price) 1.42 Current Spot price EURUSD
(Support) The 1.37 Put Option offers the right, but not the obligation, for the buyer to own a SEell position at this price