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How to Get Rich on Forex Options

by Danijel
written by Danijel

Forex Options

It has become something of a stereotype for options to be associated with stocks – so much so, that people forget that Forex options even exist, let alone that they can also yield even more profit than regular options. A combination of Forex leverage and the risk management afforded by options are a potent mix. This would enable a trader to make huge deals with minimum exposure to their funds and assets. But in order to figure out how Forex options can make you rich, you need to know about their background and basic strategies.

Forex options

When talking about options on Forex markets, most of them are either call or put options. Call Forex option entitles you to acquire some currency at a (hopefully) favorable rate, while put option entitles you to sell off some currency at the above mentioned rate (they usually come in pairs). All terms and conditions are arranged in advance and the holder gets to decide whether to exercise his or her options, try to sell them (effectively closing out his positions, maybe even turning a profit in the process) or let them expire worthless, in which case the only loss is the premium which the holder had to pay in advance to the writer of the options. SPOT options are a relatively new addition to the market, but they seem to be even more obscure than traditional options (which is a shame, really, considering the versatility they bring, but I digress).

How Forex options work

Unlike regular options, Forex options involve a pair of currencies, so buying a call option on one currency automatically means a put option on the other currency and vice versa; an option to buy a few lots of, say, GBP/USD pair would be a “GBP call/USD put”. If the price shifts your way, you can exercise the options, exchanging dollars for pounds at a prearranged (favorable) rate and immediately sell the pounds at the spot price (which should be significantly higher). The difference should be more than enough to cover the costs, including the premium for the options. If not, you can always try to sell the options and cut the losses. In the worst case, you lose the entire premium, but that is all.

Making money

Forex options are most commonly used by Forex traders who anticipate major events or shifts, as a way to maximize the profit, but at the same time leave a viable exit strategy in case things go south. Furthermore, due to their nature, Forex options are often superior to cash positions assuming the amount of money is the same; plus, options give you more… well, options. It is a lot easier to sell your options than regular positions, even if you have to sell it back to the writer. Besides, Forex options can even double as a hedging tool, which can make success all but certain.

 

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AnalysisEducationLearn to Trade

Forex Options: What are they for?

by Danijel
written by Danijel

Forex Options: What are they for?

Like all other Forex derivatives, options are primarily used for two basic purposes: one is gaining profits through speculation, and the other is risk management. A delayed trade may be a means to an end, but it certainly cannot be all there is to it. Forwards and futures are essentially delayed trades and swaps do have a practical side of their own, but options are the middle ground of sorts as well as the way to go, according to most traders.

Making money using Forex options

If Forex is about making bets on the value of a currency pair, there is a serious possibility of loss when the market goes the other way. Forex options can enable you to profit even from market events which would otherwise be adverse, with minimum investment and risk, but we’ll get to that. However, there is another side to this coin, one that gave it quite a bad name as time went by. Speculation is risky business, and doing so via Forex options will increase the price of doing business to some extent. Not only do you have to be right on the money when it comes to your predictions, but you also have to take into account the price of an option as well. In order for a Forex option to make it worth your while, the profit has to cover all the expenses, including the premium you paid for the options, and this can prove tricky at times. The price movement needs to be big enough to cover it, otherwise you lose the premium. However, if the price of an option rises in the meantime, you could just sell it and pocket the difference; it won’t make you as much money as you intended, but at least you won’t have to worry about them anymore, and you will be making money after all. What makes Forex options so profitable compared to other options is the unbelievable amount of leverage that Forex markets provide, enabling you to make huge profits on the smallest price shifts, if you play your cards right.

Risk management

When it comes to limiting losses, few financial tools can match options; the only risk is the premium, which is a fraction of the cost of the underlying instrument. Every Forex trader needs to be prepared for the worst case scenario. Futures and forwards are not the best ways to do this, because of their binding nature. If you get one of those and the market moves against you, you’re stuck between a rock and a hard place: either going through with an unfavorable deal or backing out and facing potential repercussions in terms of penalties and damage to your reputation. Forex options offer a way around these restrictions, enabling you to cut your losses and move on, while risking a mere fraction of the deal’s value and nothing else. Making money while limiting exposure is what separates true Forex traders from the rest.

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Analysis

Forex Options: Mechanics and Pricing

by Danijel
written by Danijel
Forex options

Forex Options: Mechanics and Pricing

The way Forex options work and their pricing is an important thing for any Forex trader to understand. Exercising your options is not the only way you can profit from them; options writers may issue their own options, but holders could potentially sell them to third parties. By closing their positions, holders can not only eliminate their exposure by getting their money back, they could make a profit, if the price of option has changed in the meantime or at least cut their losses.

The hard truth about Forex options

Nowadays, very few Forex options are actually exercised, and options on Forex markets are no exception. Some estimates place the number of exercised options around 10%, whereas up to 60% get re-sold to third parties or back to the writers after a while. The rest expire worthless. The truth is, most holders are aiming to close as early as possible and net themselves a nice, quiet profit rather than wait and risk. You see, in order for an option to be worth your while (if exercised in the ‘traditional’ way), the price of the underlying instrument (in this case, currency) would have to be large (or small) enough to cover the premium you paid, plus the amount you need to buy the instrument, plus any additional expenses like commissions, etc. And you need to consider that options are typically sold in bulk, so if you wish an option to buy 100 units of some currency, the premium is paid for each one of them. If the premium for an option on an instrument is $2,50 in order to buy 100 units you’d need $250 just for the premium. The fact is, price changes are rarely that large and people usually wait for the price of the option to increase so they can sell them and make a profit. So the price of an instrument may not rise or fall as much as you’d hoped for, but any changes will result in similar changes in the value of the option. That same option could be worth $3,25 the next day, and selling it would not only cover your losses but net you $75 without breaking a sweat. Naturally, Forex enables you to do this on a much larger scale, so the possibilities for profit are limitless. This example is purely theoretical, in order to illustrate the way options work.

Pricing

When first acquired, Forex options only have basic, intrinsic value. In time, they get a time value, which could be negative or positive. When combined, you get the premium. So, an option whose price rose from $2,50 to $3,75 had an intrinsic value of, say, $3,50 and a time value of $0,25 for the price of $3,75. The ‘time value’ expresses the possibility of a favorable price change (from a holder’s perspective), whereas the intrinsic value is the amount you’d get if you exercised the option on the spot. There are other factors, but their influence is minor. For lengthier explanation, please click here.

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Analysis

Forex Options: The Basics

by Danijel
written by Danijel

forex optionsWhen talking about Forex derivatives, people usually tend to neglect Forex options in favor of Forex forwards, futures or sometimes even swaps. Unlike forwards which typically require no down payment and futures which are both legally binding and costly, options offer more maneuvering space albeit at higher cost; you don’t have to actually activate the option if you don’t want to, but you still have to purchase it beforehand, and there is no refund policy for unused options. Still, it’s usually cheaper than committing to a more serious trade.

Forex options

Forex options are contracts which award their holders the right to buy or sell a currency at a certain price and within a certain time period, provided the market conditions are favorable. Otherwise, the holder can simply let the option expire, just like on other markets and move on without any liability, which is a stark contrast to forwards and futures. Other than that, the conditions are standard for all three and function similarly. Here’s how it works in real life: Let’s say the current EUR/USD pair is at 1.14363. You wish to buy €100,000 but don’t have $114,363 plus expenses. You have $3,000 and expect to have the funds in three months. You believe the Euro will increase in value dramatically in a few months, but can’t be certain; plus you’d rather not commit because you’re not 100% sure. So, you trade the $3,000 that you do have on Forex options and wait for three months. One of three things will happen: a) your hunch was on the money, the value is much greater, so you activate the option, buying at the prearranged rate and selling for the spot value, netting a nice profit. b) you’re still right, but you don’t have the money or something happened and you can’t make the trade; you cut your losses at $3,000 and move on. c) you were wrong, the price has gone in the opposite direction, and your plan essentially boils down to b). Or, you get swindled and lose your money, but this is unlikely in this day and age; possible, but unlikely.

Types of Forex options

There are call and put options; call options allow you to acquire currency while put options allow you to sell it at a certain rate. In the first case, you’re hoping the price will go up so you can buy it cheaply and sell at spot value and in the second case you’re expecting the price to drop so you can buy it cheaply and sell at a higher rate. Writers are the people who sell options and holders are the ones who buy options. Note that buying and selling options is not the same as buying and selling the underlying instruments. The writer of (Forex) call options promises to sell the currency whereas the writer of a put option promises to buy it. The holder is the one calling the shots. You can find out more about options by checking www.optionsway.com.

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AnalysisEducation

Penny Stocks or Forex: Which is Better?

by Danijel
written by Danijel

generally accepted criteria, to be honest, there are few similarities between Forex and penny stocks. In fact, they seem to be competing against each other for the favor of investors and traders alike. Since both of them are highly speculative in nature, offering huge potential payouts and minimal investments, it usually comes down to traders’ individual preferences, rather than the superior qualities of penny stocks or Forex. Naturally, there are differences and advantages, and we will get to them in time.

What are penny stocks?

Well, contrary to their name, the value of these stocks isn’t usually expressed in pennies. Not anymore. Don’t get me wrong, some stocks do trade in pennies (but aren’t penny stocks per se) while others are valued much higher than a penny (and still count as penny stocks, for some reason). There is no clear consensus as to what would constitute a penny stock, but there are some generally accepted criteria:

For one, penny stocks are stocks of a public company traded at very low prices. Their goal is usually market capitalization. The top price for a penny stock is $5 per stock, but the price alone does not define them. Furthermore, penny stocks do not trade on major exchanges; this is an ironclad rule which discounts most stocks of large companies which trade for less than $5 and would otherwise fit the description. Informal criteria for a penny stock would be high risk and low liquidity, unlike Forex which can be more versatile in this regard.

Penny stocks vs Forex

Since both Forex and penny stocks allow extremely high returns even to those who cannot afford normal stocks or huge trades, they essentially target the same group of clients. Forex offers extremely high leverage while penny stocks counter with sheer growth capacity. However, penny stocks require a great deal of effort to pick the right ones, even more than regular stocks and way more than Forex. And even successful penny stock traders will lose most of the time. Forex traders, on the other hand have huge leverage at their disposal. Currencies are arguably easier to understand than stocks, and data are readily available, in stark contrast to companies behind penny stocks. The possibility for fraud is much lower on Forex markets, and besides, pump and dump schemes may work with cheap stocks, but currency is on a different level entirely. Besides, Forex deals require as little as 1% of the trade in margin, whereas penny stocks have to be acquired and held. Even if some penny stocks offer far greater profits in the long run, Forex is faster and far more regulated. The best part is that no Forex trader is going to suffer shameless advertizing of unscrupulous penny stock “traders” looking for a sucker to scam.

Conclusion

Having said that, both penny stocks and Forex appeal to people who believe they can make a lot of money, fast. But both require years of commitment and dedication, so choose wisely.

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AnalysisStrategies

MACD in forex markets (Pros and Cons)

by Danijel
written by Danijel

MACD in forex markets (Pros and Cons)

Trend trading has been the bread and butter of Forex traders for as long as anyone cares to remember; however, trend trading is not an exact science (not yet, anyway), so knowing when to enter long trades, short trades or none whatsoever makes all the difference between rich Forex traders and their bankrupt counterparts. The MACD can serve as a good indicator when deciding on the right moment to enter the trade or leave it afterwards, even if it is… imperfect. The best example is the MACD combo strategy, but for now let’s focus on MACD itself.

Moving average convergence divergence – MACD

This concept was invented in the ’60s by Gerald Appel. The primary goal was to create a tool that would help you identify short-term momentum, and the way this is achieved is through the relationship between the short-term and long-term moving averages. MACD owes a huge chunk of its popularity to its simplicity: when the line of short-term moving average crosses the long-term line and moves up, this indicates an upward trend; if the same line crosses below the long-term line, it indicates a downward trend. In the first case, you buy, in the second, you sell; easy as pie.

Another reason for the longevity of MACD is its versatility. You get to define the ‘short’ and the ‘long’ periods in accordance with your strategy. Typically, people opt for 12 and 26 days, respectively. From there, you subtract the long-term MA from the short-term and this divergence is the working part of any MACD, making it ideal for Forex transactions.

However, there have been changes in the concept since the 1960s. One notable addition is the signal line, a separate moving average representing the MACD itself, usually for a 9-day period. So your modern MACD has two lines: one stands for your current MACD and the other is the exponential moving average of your MACD, and their crosses act as buy and sell signals, depending on the direction in which they cross. Some even went as far as to introduce the zero line; basically, every time the averages cross, the MACD is technically zero at that point. A line connecting these points is the zero line, and it supposedly helps determining the direction of a trend.

Pros and cons

MACD is a versatile tool that can help you analyze tons of data in a simple and efficient way, making it ideal for trading currencies and such. The primary objective is to determine the short-term trend direction, and MACD is very good at that, if used properly. However, relatively few people manage to do so. Most end up getting in and out of trades in quick succession as the line zigzags through the chart. All these false alerts can cost you more than nerves – they cost money, too. Another major drawback is that MACD focuses better on a single currency instead of a pair, which can make things tricky.

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AnalysisEducationSignals

MACD combo

by Danijel
written by Danijel

“Moving Average Convergence Divergence”, or MACD, while of little importance to lay people, can and does mean a lot to modern Forex traders. You see, identifying trends and capitalizing on them should be a piece of cake, even for total rookies – in theory. In real life, however, it takes some considerable effort to identify and predict future trends. Moving averages help, but even they can only go so far. This is where the MACD steps in.

MACD combo

What is Moving Average Convergence Divergence?

Let’s start from the basics: MACD is a type of indicator that helps you compare moving averages. For instance, if you take a 12-day exponential moving average and deduct a 26-day exponential moving average from it (and keep in mind that both averages need to refer to the same stock, commodity or in this case, currency), you get the MACD for the underlying financial instrument. From there, you just need a ‘signal line’ of sorts, typically a 9-day exponential moving average and you’re set. This should give you an accurate indicator telling you whether to buy or sell. Namely, whenever the MACD gets below the line, it means the price is going to fall and it’s time to sell and vice versa – when it gets above, it means buying is a good idea. Of course, this does not necessarily mean anything beyond a possibility, but keep in mind that many Forex traders keep an eye out for this sort of thing, and their combined actions may eventually push the price in the predicted direction regardless of other issues. Then again, people have been burned quite a few times, and many opt to wait for confirmation before going through with any trades. This course of action seems safest. Naturally, no trend lasts forever, and the divergence between the MACD and the actual price is the proof of this.

How can MACD be used by Forex traders?

Forex traders can base their trades, long and short alike, on the MACD combo trading strategy. MACD combo enables them to begin trend trading at an opportune moment and end before it’s too late. Rather, it can tell them if this is a good time to get in on a trend or get out as it is drawing to an inevitable end. Although, a strategy is only as successful as the one who employs it, something many Forex traders come to find all too late. For a long trade, you engage if the price is above the nearest moving average by some 10 pips and went positive within the last five bars. The exit point is 10 pips below the shorter moving average. Just don’t forget the stop position, five bars below the entry in the beginning and moved to the break even point during the trade. Short trades work similarly, except the price is supposed to break downwards and plummet instead of rising. Basically, if MACD combo executed right, this strategy can yield huge profits at very low risk.

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Analysis

Spot Markets vs Futures Markets

by Danijel
written by Danijel

Spot Markets vs Futures Markets

While it is not uncommon for beginners to confuse spot and futures markets, there is a (somewhat) clear distinction between the two. The main (and obvious) difference is that spot markets employ a “cash & carry” policy, where the commodities (or securities, etc.) are delivered immediately upon payment, or shortly thereafter, whereas futures markets employ a longer delivery period, and/or a delayed transaction. However, there is more to these two than meets the eye, and we are about to see why.

What are the spot markets, and how exactly does it differ from futures markets?

Well, a spot market (sometimes called a physical market) is a type of market where the monetary transaction and delivery are carried out simultaneously, or one closely follows the other. Any contracts made on this type of market are realized immediately. This is the traditional type of market, and the principles are as old as trade itself. However, modern times have changed them somewhat, and this gave way to some gray areas: apparently, even futures can be traded on spot markets, as long as the delivery period is 30 days or less. The exact delivery period may be open to debate, but after stretching it that long, can we even talk about spot and futures markets being separate? Actually, we can, for now. Futures markets, on the other hand, enable you to arrange a transaction but postpone it for another date, hoping that the conditions will be more (or less) favorable than they were at the time the deal was struck. But given how volatile financial markets are, the line often gets blurry. It all depends on how long does it take to assume ownership over newly acquired property, or asset.

What does this mean for Forex traders?

When you’re trading currencies, you get to choose between currency futures or the good, old-fashioned (spot) Forex market. Since the whole point of Forex trading is to acquire a certain amount of currency and wait for its value to increase so you can make a profit, there are some similarities between buying it outright and pre-arranging a trade but not concluding it until a later date. Those who opt for the latter possibility, can either use the currency they own at that point in time, or kind of “hope to be able to afford it” by the time the transaction is concluded – a risky strategy at best, since a currency future is legally binding, and an inept Forex trader can find himself in a world of hurt. However, if the spot price changes significantly in the meantime, the gambit will pay off and the trader will profit immensely.

As with other markets, the difference between spot and futures Forex markets is the moment the exchange happens; if it is immediately after payment, we are talking about a spot market. Otherwise, chances are this is a futures market. Just remember: very few futures contracts are actually concluded as planned.

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AnalysisStrategies

Covered Interest Arbitrage Strategy

by Danijel
written by Danijel

Getting a currency forward can be a tricky business even for a major player on the Forex market, let alone for a small-time trader; however, if the general conditions are met and the counter party is willing, the time is right for determining the covered interest arbitrage strategy. The thing is, you cannot simply implement your covered interest arbitrage strategy on the fly. You need something called the direct quotation method to determine what your strategy should be like and if it can even be implemented. You need to know the exact ratio between currency A and currency B, and the direct quote can help you with that. Basically, it tells you how much currency A do you need to buy a single unit of currency B (let us say Bitcoin). In any case, if you know both the spot and the forward rate (and you have the means), you’re in business.

covered interest arbitrage

How does covered interest arbitrage strategy work?

Well, first you need to figure out how much would a forward contract be worth after the specified period of time. Between the risk-free rates for both currencies involved, plus the spot and forward exchange rates, it should be no problem for an astute trader to quote the regular forward contract. This is where the plot thickens. You need to decide whether to enter into a currency forward contract or not. You need to divide the currency B/currency A spot rate by the risk-free rate for currency A plus one, and then multiply that by the risk-free rate of currency B plus one. In other words: (X/(1+Y)) * (1+Z), where X is the spot exchange rate, Y is the risk-free rate of currency A and Z is the risk-free rate of currency B. If the result is lower than the quoted price of a forward contract on the open market (which you knew in advance), this means the current forward contract is overpriced, and should be sold in order to make a profit. If the opposite is the case, then it is under priced and acquisition is the shrewd move. If you decide to sell a forward contract, you would need to calculate how much of currencies A and B would you need: spot rate/(1 + risk-free rate for currency A) and 1/(1 + risk-free rate for currency A). After figuring that out, you sell the forward contract at the quoted price. Next you need to hold the position for currency A until it’s time to settle the contract, and when that time comes, you pocket the difference, provided things went according to plan. Of course, this is a textbook example and is only meant to illustrate the concept. Ordinary traders are still unlikely to sell their own forward contracts, if for no reason other than the fact they cannot offer the gargantuan sums required for such an endeavor. However, the basic principle stands, and can be applied to any kind of derivative on the market.

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Analysis

Currency Forward Derivative Contracts

by Danijel
written by Danijel
Currency Forward Derivative Contracts

Currency Forward Derivative Contracts

The two best qualities of a currency forward contract are its versatility in terms of general conditions, quantities and time frame as well as the fact that it requires virtually no down payment of any kind, so there are no standards set for this kind of derivative, unlike currency futures, the next closest thing. However, the very essence of Forex markets is linked to currency forward contracts, and here is how:

Forex market is not your average exchange office

There is a huge difference between how currencies are exchanged with the general public, on the streets, and the way they are quoted on a Forex market. Your local exchange office offers a fixed exchange rate for the day, and it rarely changes outside of regular schedule. This way, it doesn’t matter if you forgot to stop by this morning, since you can just exchange your currency on your way home; the exchange rate should be the same, right? Well, Forex markets do not normally work this way. Exchange rates vary every second or two, and every pip counts. Furthermore, due to the sheer volume of cash being exchanged, Forex traders could stand to lose a fortune in a single transaction, due to a sudden price change of a particular currency pair. Now mind you, these guys are not your average workers, looking to exchange $100 in order to get some spending money in some local currency, these guys mean business; we are talking about millions, and in this case every single pip matters. When found in this type of precarious position, you tend to minimize the risk, or even eliminate it completely, if you can. With a currency forward, a trader or a major player on Forex markets can ensure a favorable exchange rate in the next period, in order to lock in the profits.

Conclusion about Currency Forward Contract

However, this does not come without a price: currency forwards may essentially be hedging tools for the super rich, but they do come with their own share of risks and flaws. First of all, there is no clearing house to ensure everything goes as planned. Furthermore, you still need a counter party for this little arrangement. And if a bank or an institution is doing your forwards for you, they may still require a deposit and/or a margin even though they have no such responsibilities towards their counter parties. In other words, your bank doesn’t need to pay anything up front, but you do. And the best part is yet to come: most parties arranging currency forwards do not actually have the currency on them (if they did, wouldn’t they exchange it outright?). Rather, they expect to have it in due time. The thing is, currency forward derivative contracts are legally binding, so simple default is rarely an option. Plus, the exchange rates change all the time, and even if everything goes according to plan and you get the money, if the spot exchange rates are more favorable – tough luck.

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