The beauty of trading currencies is that it is possible to trade them in the spot market as well as in the options market. Many retail traders are rushing off to trade forex and using many forex signals services to do so. But how many of them are actually trading forex options? Very few indeed, which is a shame because you can actually get the best of both worlds from a single paid signals service.
Now in trading forex options, you can either buy options or sell options. Both styles have their advantages and disadvantages. Never get swayed by any hype you read online until you get acquainted with the facts.
Buying options may look cool, but there are inherent risks to that style of options trading. Whenever you buy a forex option or an option on any other financial instrument for that matter, you have to pay some money to the dealer for this and this is called a premium. The moment you get into a trade, the premium is deducted from your trading account, putting you in debit. To profit from a BUY option, you need the price to move in your chosen direction in such a way as to cover the cost of the premium and leave you with some profit at the end of the day. Even though your loss potential is limited to the premium paid on the trade, you are always under performance pressure, especially as studies have shown that 75% of all options trades end up worthless on expiry.
Selling options looks more appealing. You get paid a premium when you open a trade. You also benefit from keeping the premium when the trade expires worthless. So you have a much better chance of winning a sell option trade than a buy option. This does not make it easier to spot the opportunity, and selling options exposes you to unlimited losses. That is why as part of a sell option strategy, you need to buy an option on the same asset at a higher price to cap your losses.
What Can You Sell As an Option?
Both Call and Put options can be sold on a currency pair. Your aim is to sell an option which will expire worthless. Selling an option is a contrarian trade which is setup so the asset goes against the direction of the option. A Call option traditionally favours higher prices, and a Put option favours lower prices. So by selling these options, you are actually betting on price going lower for a Call option, or price moving higher for a Put option.
Rather than spend time and energy performing trade analysis, you can simply select a good forex signals service, and sell the option against the projected direction of the asset as predicted by the signals service.
You have to be sure of the service you choose as this will be the ultimate decider on whether you will be profitable or not.
How to Setup the Forex Options Sell Trade
It is assumed you have a trading account with a broker that offers forex options trading.The presumption here is that the trader will follow the trade signal’s direction. When you receive the forex signal to buy or sell the asset, open a Sell option which follows the signal direction, then cover the trade by opening an opposing trade to cap the losses that may occur.
- If you get a signal to sell a currency, initiate a Sell Call option and at the same time, initiate a Buy option on the underlying asset. This move ensures that you get the premium from the initial trade, and at the same time, cap your losses. See the example below.
In this example, the forex signals provider sent a signal to go short on the GBPUSD. This was done following the December 2016 rate hike by the US Federal Reserve. The expectation was that this move would boost US Dollar strength, causing the GBPUSD to head lower. A Sell Call option was initiated at a price of 1.25343, and a premium of $316.12 was paid to the trader. However, there is always a potential for the GBPUSD to start to turn upwards. If this happens, this could lead to unlimited losses, since there is no indication of how far any upside move would go. To cap the losses on this trade, the trader then initiated a Buy option on the GBPUSD at a higher price of 1.2790, with a premium of $84.12 deducted from the trader’s account.
Assuming the trade stays where it is, or keeps going south, the trader would earn $316.12 – $84.12 = $232 when this option expires.
Several sell option trades can be setup in this manner using your regular forex signals service.
Disclaimer: It must be emphasized that trading options on currencies is very risky and must be done by those who have undergone some training. You can also lose your entire capital, so only trade with money you can afford to lose.