Currency Futures Options – Is it the Best Way to Trade Forex?
Before deciding whether it is worth your while trading currency futures options you should first understand the nature of currency futures and their associated risks. Currency futures options are becoming less popular since the appearance of many brokers that allow you to trade the spot price of a currency pair, (as opposed to a future price at a specified date) with the same degree of leverage but without the same risk that comes with futures contracts.
If all currencies were fixed in value relative to one another, there would be no need or opportunity for currency futures or their offshoot, currency futures options. Because currencies rise and fall in value on a continuing basis, there is a corresponding need for international commerce to guard against currency fluctuations that might significantly alter their profitability on sales that are denominated in one currency, but transferred back to a home currency, which may be falling in relative value.
This can lead to substantial effective losses, so large organizations and government seek to hedged their risk by using forex futures options that essentially fix the exchange rate in place, in return for a small premium. Certainty thus becomes a major factor in this sort of trade.
Trading Currency Futures Options
Another but increasingly less popular reason why people trade in currency futures involves pure speculation. This is where professional currency traders bet on the rise and fall of various national currencies based upon their understanding of the likely movement in currency values as laid out in published economic data.
Currency pairs are about the value of one currency compared with another. These are affected by many factors but in the end, it’s all about supply and demand. Economic conditions and important announcements are a major factor affecting the relationship of one currency to another. For example, a rise in interest rates payable by one country as opposed to those offered by another, can lead to monetary shifts. Other economic conditions such as rising inflation or demand for one country’s resources affect currency fluctuations. Political considerations can also alter the perceived value of a currency. The result is an ever-shifting balance between individual currencies.
Currency futures options are an alternative trading or hedging vehicle built upon the basic principle of futures contracts. They give traders the right, but not the obligation, to buy currency 2 at a set price denominated in currency 1. If this turns out to be a profitable transaction, the option is exercised. If it is out-of-the-money upon expiration, the trader simply declines to exercise his option, and takes the small loss involved in purchase of the option.
The net benefit of currency futures options as opposed to currency futures contracts is therefore one of less profitability due to the payment of the option price, in return for greater security through insulation from the mandatory delivery nature of futures contracts.