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TRADING FX OPTIONS
FX Options have often been seen as an exotic and complex form of trading, but the truth is they are quite simple. Calls and puts give us a streamlined and leveraged way to take positions long or short in the market. They also offer the capability of fixing maximum loss when you are buying them, as you cannot lose more than the premium.
More sophisticated strategies for proficient traders, such as straddles, strangles or collars, can also be a source of profits with limited risks. Options can also be looked at as a hedge in FX spot positions. Examples include being long GBP/USD and long a put for protection, or short a call.
What do professional traders look at when they trade options? They look at a set of data known as the Greeks, as they are each named after a letter from the Greek alphabet.
The first factor they are looking at is volatility (Vega), which on its own is the biggest driver of option prices. They also observe delta, which is how much in or out of the money the strike of the option is.
Time decay (Theta) is also significant and constitutes the rate of change of delta (Gamma).
The most important Greeks from a non-institutional trader’s point of view are Vega and Theta. Time decay (Theta) can have a big impact on the value of an option, especially when the price does not go anywhere. Theta is always negative and the further away the expiry date, the more expensive the option will be.
Vega is the price or level of volatility in the market. It should always be looked at carefully, as going long an option at a very high level of volatility can be disastrous if the level of volatility moves back down to previous levels. The strike price is also significant. The more out of the money a strike is, the cheaper the option and the less likely you are to see profits.
You can also look at options as a play on volatility, which is how institutional traders look at it. One of the most common trades on volatility is to buy or sell a straddle. This involves simultaneously buying or selling a call and buying or selling a put with the same expiry and the same strike prices, usually at the money. So your total position is either long both call and put or short both call and put. You can see that if the market remains virtually unchanged, the seller of this strategy will come out a winner; whereas the buyer will make money if the markets move in either direction.
The Foreign Exchange option market is one of the most extensive and liquid option markets around. In 2013, according to BIS, the option market traded $337 billion, more than a 50% increase from the last survey in 2010 at $207 billion.