There are now three domains in which you may trade currencyoptions: 1 Two exchanges trade listed currency options; 2 you can spread-betcurrency options at any of the spread betting opera
Trang 15 Extra for Experts
Part
Trang 3Options and Exotics
Chapter
At the Interbank level, options have been an integral part of the FOREX
landscape for many years It is estimated that options may comprise up
to 10 percent of FOREX market share, a substantial portion for hedgingpurposes by banks and corporations
A bank may be at risk on an international loan for a short period of time.Hedging with currency options can eliminate that risk Hedging acts as aninsurance policy If the bank is at risk on the long side of the EUR/USD, theycan take the opposite position in options A corporation might do the samewhile awaiting payment on a large sale Loss on the business-side transaction iscompensated by a profit in the hedge For retail currency traders, speculativeoptions trading has been the domain of seedy boiler-room operations untilrecently There are now three domains in which you may trade currencyoptions: (1) Two exchanges trade listed currency options; (2) you can spread-betcurrency options at any of the spread betting operations mentioned in Chapter
13, “The FOREX Marketplace”; (3) several reputable retail broker-dealers nowoffer FOREX options on 10 or more pairs and with a wide variety of features Inow recommend traders who wish to work with currency options use a retailFOREX broker The advantages and convenience of being able to trade spotFOREX and the corresponding FOREX options under one roof is substantial.Exotics, currency pairs with the USD or EUR, and a small or exotic coun-try’s currency provide exceptional opportunities along with higher risks than themajors or top-tier crosses They offer variety, have trading personalities all theirown, and may be especially attractive if you have some knowledge or insightabout the exotic country other traders do not
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Trang 4For speculation, options can be used as either a trading instrument or as amoney management tool paired with spot FOREX trading.
I strongly advise new traders to become fully comfortable in the spotFOREX space before considering options Because of the additional time valuecomponent, the matrix of possibilities and strategies can be enormously com-plex and mathematically heady
In options time is not on your side It is a constantly deteriorating ing) value The price of the underlying currency must not just move in yourfavor to make money; it must move enough to compensate for the time decay.Every options trader has experienced this: The call is due to expire soon andsuddenly the underlying vehicle (a stock, a commodity, a currency pair) begins
(decay-to move up, sometimes dramatically But the option is decaying even faster thanthe underlying vehicle is going up The result: The price of the option continues
to go down In the meantime, the buyer of the spot pair has made a tidy profit
An Options Primer
An option is the right to buy or sell the underlying currency at a specific price for
a specified period of time You can purchase an option or write an option Forspeculative purposes, purchasing is most common
The right to buy is a call You have the right to call the position away fromsomeone holding the spot equivalent
The right to sell is a put You have the right to put a spot position to someone.You purchase a call if you believe the currency price is headed up You pur-chase a put if you believe the currency price is headed down An option is a con-tract between a buyer and a seller; the seller is termed the writer, the buyer is thepurchaser
Basic Options Terms
The strike price is the price at which the call or put may be exercised It doesnot make sense to exercise a call or put (exchange it for a spot position) unless
Trang 5the call or put is in-the-money—trading above (call) or below (put) the strikeprice.
You may, of course, offset your option, buying it back (a put) or selling it (acall) before the expiration or even if it is not in-the-money You have effectivelytransferred your contractual obligation to someone else You might purchase acall out of the money and sell it out of the money and still profit thereby.The expiration is the time frame of the option In stocks and commodi-ties, these are normally set for months An option is said to expire in September,for example In FOREX the expiration dates are closer since very few tradershold positions for months at a time
The premium is the cost of the option With options you are paying forthe time-value as well as the price values The underlying value of the optionfalls as time approaches the expiration—unless the price value increases at afaster rate Options pricing, because of these twin values, can be complex andunpredictable You can be correct on the price direction and still lose moneybecause of decaying time values
The intrinsic value of an option is what it is worth if exercised at any giventime When an option is out-of-the-money its only intrinsic worth is time value
A call is in-the-money if the spot price is above the strike price; money if below A put is in-the-money if the spot price is below the strike price;out-of-the-money if above
out-of-the-The price of an option, or premium, is determined primarily by strike andexpiration vis-à-vis the current price of the underlying currency But there areother factors such as liquidity, speculative fervor, and volatility For example, anout-of-the-money call is more valuable if the underlying currency is volatile; ithas a better chance of going to in-the-money Forecasting option prices—evenknowing or inputting the price of the underlying currency—is far from an exactscience A small change in time value or price value may cause the option price
to change by an inordinate amount The various price factors appear to interact
in a nonlinear fashion Mathematic whizzes will find a similarity to the famous
n-body problem.
A vanilla option is one with only the basic components of expiration dateand strike price An exotic option contains complicated features and complexpayoffs that often are determined by outside factors Exotic options are mathe-matically complex; going to the moon was easier than predicting exotic options
in the author’s humble opinion
Traditionally, currency options have been of two types:
American-style: This type of option may be exercised at any point up until
expiration
European-style: This type of option may be exercised only at the time of
expiration
Trang 6And they call us crooks!
If you trade with options, consider only American-style, vanilla
The Pros and Cons of Options
Major pro: Buying options limits your exposure The maximum you can lose isthe value of the option, the price you paid for it
Purchasing options as a speculative vehicle offers limited downside—youcannot lose more than the price you paid for the option—and unlimited upside,
at least on a call If you purchase a put, your profit is technically limited to theunderlying currency going to zero
The cost of the option may be less than the margin on the same spotposition
Major con: You pay for the time value of an option In spot FOREX otherthan rollover charges (typically small), you do not pay for the time you hold aposition
Forecasting option pricing—even given the price of the underlying currency—is difficult
If your option expires worthless, you lose your entire purchase price Thiscan occur from prices moving sideways and the time premium decaying tozero If prices move sideways for the spot trader, he loses nothing and retainshis margin funds You may find prices of the currency moving in your favor butnot fast enough to compensate for the time decay—a discouraging predica-ment most options traders have experienced more than once If the time onyour option expires and the option is out-of-the-money, its value is zero (SeeFigure 19.1.)
Currency Pair Price
Option Price
FIGURE 19.1 The Downside of Options
Trang 7The Four Basic Options Strategies
Terminology note: Be careful not to associate “buying” with calls only You mayalso buy or purchase a put
Profit if the put buyer is incorrect
Purchasing and Writing Options
You may purchase either a call or a put, although it may sound strange to chase the right to sell
pur-You may either purchase or write an option—either a call or a put.Remember, an option is a contract between a purchaser and a writer An optionwriter collects the premium as income from the purchaser The writer of a callmust be ready to have his spot position called away or purchase a spot position
if the buyer exercises his option The writer of a put must be ready to purchase(or repurchase) the spot position from the buyer of the put
If a writer holds a spot position when he enters an options contract, he issaid to be a covered writer If he does not hold a position, he is said to be uncov-ered or a naked writer
Advanced Options Strategies
As I have mentioned, the mathematics of options is enormously complex Thereare many high-level options strategies based on combinations of puts/calls,writing/purchasing, different strikes and expirations They are not for the newtrader!
Some of these have exotic names such as “condor” or “butterfly” derivedfrom the graph of profit/loss calculations for the strategy (See Figure 19.2.) Iknow, not much more impressive than the so-called Big Dipper constellation.But where would we be without imagination?
Trang 8The Greeks
A number of Greek letters have found their way into options terminology;Delta, Gamma, Rho, and Theta
Delta is a measure of the change in the price of the option resulting from
a change in the price of the underlying currency pair
Gamma is the change in Delta
Rho relates the options price to the prevailing interest rate
Theta is the change over a fixed time period with all other factors ing unchanged
remain-Vega, neither Greek nor Chevrolet, relates options price to implied volatility.Enjoy!
The Retail FOREX Options Landscape
There is a substantial over-the-counter (OTC) FOREX options market—this hasbeen around for many years But it is only open to banks, institutions, and largecorporations Fortunately large broker-dealers are beginning to tap into thisarena and offer it to their customers
Spread-betting companies offer currency options, as well See Chapter 13,
“The FOREX Marketplace,” for a list of spread-betting companies
I recommend you start with one of these if options appeal to you
Trang 9perhaps a handy feature if you are new to options and have questions alongthe way.
They advertise: Instant execution, accept request for prices on any date onany currency pair, Delta-based pricing, Market and Limit orders, State-of-the-art risk management
PFG Best www.pfgbest.com
Best direct was originally an old-line commodity futures house Options onfutures have been around many years Their no-double margin—combinedmargin for spot and options trading—might be a useful feature for the astutetrader
SaxoBank www.saxobank.com
SaxoBank was one of the first broker dealers to offer currency options; the gram is now called the FX Options Trade Board They have extensive informa-tion on their web site Features: 40 currency pairs are offered with options, shortdate to one-year expiry, live streaming quotes, no dealer intervention They alsooffer options on gold and silver
pro-Oanda www.oanda.com
Oanda offers a unique BoxOption Traders define their own option by drawing
a box on the currency chart whether they believe the exchange rate will ally move to hit or miss the custom box The trader also chooses the purchaseprice for their box The system (I assume a complex algorithm) then calculates apayout based on the likelihood the box will be hit (open box) or missed (closedbox) It is all or nothing You collect if the box is hit (or missed) and forfeit thepurchase price if the box is missed (or hit)
eventu-Here you are trading against Oanda’s algorithm as well as the underlyingcurrency pair I am sure astute mathematicians are already at work attempting
to reverse-engineer the algorithm I am equally sure that if someone comes tooclose to achieving such an august aim, the algorithm will be modified beforeyou can even say, “Send me my money!” See Figure 19.3
Options for Trading
If you have concluded that a currency is going up or down in price, you maybuy a call or buy a put on the currency The number of pairs offered to retail
Trang 10traders is growing quickly Two or three years ago only the majors were available;today some brokers offer them on more than 40 pairs You gain the advantage oflimited risk but pay for that limited exposure Much like an insurance policy, ifyou do not use it, it is lost.
Unfortunately, that limited risk tends to lull inexperienced traders into afalse sense of security They do not have to make a decision about getting out of
a bad trade because of a margin call and are prone to let a losing trade ride untileither the price of the currency is so far away and/or there is so little time valueremaining that the option expires worthless As a young trader in 1973 I watched
my five Ford options slide from 11/2 to zero over a two-week period “Tomorrowwill be a better day.” Tomorrow never came Always keep in mind the basicoptions position You may see the currency price go in your favor but the timevalue decays at a faster rate The net result is that your option goes down in value
Options for Money Management
Options for money management make a lot of sense but require significantstudy, experience, and discipline for the strategy to work properly There are
FIGURE 19.3 Oanda BoxOption
www.tradeviewfx.com and www.metaquotes.com
Trang 11three basic strategies for money management with options but dozens ofpermutations on them Remember, no matter how sophisticated your strategy
is, you still must be correct about the price movement of an option to make aprofit There is no magic in the torturing of the numbers, friend
These four strategies are based on long the EUR/USD
Strategy 1: Perhaps you entered a market with extremely high volatility;
long the Euro, short the U.S Dollar (EUR/USD) just before an importantnews announcement is due You might purchase a put on the Euro Onceprices begin to move in your favor, you can raise your stop to a break-evenpoint and sell the put Of course, you have lost money on the put, but youhave bought time to allow your position to stabilize in your favor If thetrade moves against you instead, the option will cover at least a large por-tion of your spot trade loss
Strategy 2: Perhaps you have a long-term trade in mind and plan to hold
the position over several days A put helps anchor your position againstthe risks and vagaries of a long-term hold In FOREX the risks associatedwith long hold periods are substantial
Strategy 3: In this scenario of a long-term hold, you could write a call
against your position and collect income during the holding time from thepurchaser of the call You must calculate the value of the income versus therisk of having your spot position called away from you
Strategy 4: You find a great trade, but the stop-loss would be too far
away for your trading profile or perhaps a new report is pending Youcan sell the spot pair and simultaneously buy a call option As soon asyour primary trade (the spot pair) reaches a point where you can place
a break-even stop-loss, you cover (sell) the call option You will losesome money on the option but if the pair performs according to yourexpectations, then being able to take the trade justifies the cost SeeFigure 19.4
Options are relatively expensive You might think a good strategywould be buying both a short-term call and a put before a big newsannouncement would be effective If prices move dramatically, the profit onone will more than compensate for the loss on the other Others also haveconsidered the idea Option prices spike before such events, making a profitunlikely except for a quite extraordinary price move There is no free lunch;sophisticated traders and researchers have almost certainly already studiedand/or tried any strategy you may discover Said another way—the marketsare efficient
Trang 12Terminology is not consistent throughout the industry: a major is a pair sisting of currencies from the United States (USD), Great Britain (GBP), Japan(JPY), Europe (EUR), Australia (AUD), and Canada (CAD) An exotic is one
con-of these (usually the USD or EUR) and one con-of the currencies shown in Table 19.1
A pair composed of two exotic currencies is called asking for trouble Exoticsmay also be called emerging, although there is not a strict one-to-one relation-ship between the two
Exotics are illiquid—there is much less trading in them than in the majors
or minors The degree varies; the Polish zloty is relatively liquid while the Thaibaht is very illiquid The lack of liquidity means that pip spreads are high andlarge orders may be difficult to execute Risks are greater but so is profit potential.Generally the best fills are during the appropriate session relative to theexotic: European session for the Zloty, Asian session for the Baht Fills are anissue for exotic traders and make short-term trading difficult because such costmust be figured into the equation Fifteen pips on a 50-pip swing is too rich but
on an anticipated 200 pips it may be livable
FIGURE 19.4 An Options Strategy for the Spot Trader
Courtesy Tradeview Forex, www.tradeviewforex.com, and MetaTrader, www.metaquotes.net