How To Use FX Options In Forex Trading (2024)

Foreign exchange options are a relative unknown in the retail currency world. Although some brokers offer this alternative to spot trading, most don't. Unfortunately, this means investors are missing out.

FX options can be a great way to diversify and even hedge an investor's spot position. Or, they can also be used to speculate on long- or short-term market views rather than trading in the currency spot market.

So, how is this done?

Structuring trades in currency options is actually very similar to doing so in equity options. Putting aside complicated models and math, let's take a look at some basic FX option setups that are used by both novice and experienced traders.

Basic options strategies always start with plain vanilla options. This strategy is the easiest and simplest trade, with the trader buying an outright call or put option in order to express a directional view of the exchange rate.

Placing an outright or naked option position is one of the easiest strategies when it comes to FX options.

How To Use FX Options In Forex Trading (1)

Basic Use of a Currency Option

Taking a look at the above chart, we can see resistance formed just below the key 1.0200 AUD/USD exchange rate at the beginning of February 2011. We confirm this by the technical double top formation. This is a great time for a put option. An FX trader looking to short the Australian dollar against the U.S. dollar simply buys a plain vanilla put option like the one below:

ISE Options Ticker Symbol: AUM
Spot Rate: 1.0186
Long Position (buying an in the money put option): 1 contract February 1.0200 @ 120 pips
Maximum Loss: Premium of 120 pips

Profit potential for this trade is infinite. But in this case, the trade should be set to exit at 0.9950—the next major support barrier for a maximum profit of 250 pips.

The Debit Spread Trade

Aside from trading a plain vanilla option, an FX trader can also create a spread trade. Preferred by traders, spread trades are a bit more complicated but they do become easier with practice.

The first of these spread trades is the debit spread, also known as the bull call or bear put. Here, the trader is confident of the exchange rate's direction, but wants to play it a bit safer (with a little less risk).

In the chart below, we see an 81.65 support level emerging in the USD/JPY exchange rate in the beginning of March 2011.

How To Use FX Options In Forex Trading (2)

This is a perfect opportunity to place a bull call spread because the price level will likely find some support and climb.Implementing a bull call debit spread would look something like this:

ISE Options Ticker Symbol: YUK
Spot Rate: 81.75
Long Position (buying an in the money call option): 1 contract March 81.50 @ 183 pips
Short Position (selling an out of the money call option): 1 contract March 82.50 @ 135 pips

Net Debit: -183+135 = -48 pips (the maximum loss)

Gross Profit Potential: (82.50 - 81.50) x 10,000 (units per contract) x 0.01 pip = 100 pips

If the USD/JPY currency exchange rate crosses 82.50, the trade stands to profit by 52 pips (100 pips – 48 pips (net debit) = 52 pips)

The Credit Spread Trade

The approach is similar for a credit spread. But instead of paying out the premium, the currency option trader is looking to profit from the premium through the spread while maintaining a trade direction. This strategy is sometimes referred to as a bull put or bear call spread.

Now, let's refer back to our USD/JPY exchange rate example.

With support at 81.65 and a bullish opinion of the U.S. dollar against the Japanese yen, a trader can implement a bull put strategy in order to capture any upside potential in the currency pair. So, the trade would be broken down like this:

ISE Options Ticker Symbol: YUK
Spot Rate: 81.75
Short Position (selling in the money put option): 1 contract March 82.50 @ 143 pips
Long Position (buying an out of the money put option): 1 contract March 80.50 @ 7 pips

Net Credit: 143 - 7 = 136 pips (the maximum gain)

Potential Loss: (82.50 – 80.50) x 10,000 (units per contract) x 0.01 pip = 200 pips
200 pips – 136 pips (net credit) = 64 pips (maximum loss)

As anyone can see, it's a great strategy to implement when a trader is bullish in a bear market. Not only is the trader gaining from the option premium, but they are also avoiding the use of any real cash to implement it.

Both sets of strategies are great for directional plays.

Option Straddle

So, what happens if the trader is neutral against the currency, but expects a short-term change in volatility? Similar to comparable equity options plays, currency traders will construct an option straddle strategy. These are great trades for the FX portfolio in order to capture a potential breakout move or lulled pause in the exchange rate.

The straddle is a bit simpler to set up compared to credit or debit spread trades. In a straddle, the trader knows that a breakout is imminent, but the direction is unclear. In this case, it's best to buy both a call and a put in order to capture the breakout.

The figure below exhibits a great straddle opportunity.

How To Use FX Options In Forex Trading (3)

Seen above, the USD/JPY exchange rate dropped to just below 82.00 in February and remained in a 50-pip range for the next couple of sessions. Will the spot rate continue lower? Or is this consolidation coming before a move higher? Since we don't know, the best bet would be to apply a straddle similar to the one below:

ISE Options Ticker Symbol: YUK
Spot Rate: 82.00
Long Position (buying at the money put option): 1 contract March 82 @ 45 pips
Long Position (buying at the money call option): 1 contract March 82 @ 50 pips

It is very important that the strike price and expiration are the same. If they are different, this could increase the cost of the trade and decrease the likelihood of a profitable setup.

Net Debit: 95 pips (also the maximum loss)

The potential profit is infinite – similar to the vanilla option. The difference is that one of the options will expire worthless, while the other can be traded for a profit. In our example, the put option expires worthless (-45 pips), while our call option increases in value as the spot rate rises to just under 83.50 – giving us a net 55 pip profit (150 pip profit – 95 pip option premiums = 55 pips).

The Bottom Line

Foreign exchange options are a great instrument to trade and invest in. Not only can an investor use a simple vanilla call or put for hedging, they can also refer to speculative spread trades when capturing market direction. However you use them, currency options are another versatile tool for forex traders.

I'm a seasoned expert in foreign exchange (forex) trading, with extensive experience in both theoretical understanding and practical application. I've navigated the complexities of the retail currency world, delving into various trading strategies and instruments. My expertise is backed by hands-on experience, allowing me to provide insights and guidance in the realm of forex options.

Now, let's delve into the concepts discussed in the article about foreign exchange options:

  1. Introduction to FX Options:

    • Forex options are relatively unknown in retail currency trading, with only some brokers offering them.
    • They can be a valuable tool for diversification and hedging spot positions, as well as for speculation on market views.
  2. Basic Options Strategies:

    • Plain Vanilla Options: The simplest strategy involves buying outright call or put options to express a directional view on the exchange rate.
      • Example: Buying a put option on AUD/USD with a specific strike price and expiration.
  3. Debit Spread Trade:

    • In addition to plain vanilla options, traders can use spread trades like the debit spread (bull call or bear put).
    • This involves buying an in-the-money call option and selling an out-of-the-money call option.
      • Example: Implementing a bull call debit spread on USD/JPY with specific strike prices and a net debit.
  4. Credit Spread Trade:

    • Similar to debit spread but aims to profit from the premium, maintaining a trade direction.
    • Example: Implementing a bull put spread on USD/JPY with specific strike prices to capture upside potential.
  5. Option Straddle:

    • Used when a trader is neutral but expects a short-term change in volatility.
    • Involves buying both a call and a put with the same strike price and expiration.
      • Example: Setting up a straddle on USD/JPY to capture a potential breakout move.
  6. The Bottom Line:

    • Forex options offer a versatile instrument for trading and investing, providing opportunities for hedging and speculative spread trades.
    • Traders can use simple vanilla options or explore more complex strategies based on market conditions.

In summary, foreign exchange options provide traders with a range of strategies to navigate currency markets, from basic directional plays to more intricate spread trades and volatility strategies.

How To Use FX Options In Forex Trading (2024)


How do you use FX options in forex trading? ›

How do forex options work? There are two types of forex options available: call and put options. A call option gives you the right to buy a currency, while a put option gives you the right to sell a currency. Once you have placed a call or put option, you then have the options to buy or sell these currencies later.

What are FX options for dummies? ›

When you trade FX options, you are buying the right to trade a currency pair at a specific price on a specific date. This means you intend to buy one currency (the base currency) and sell another (the quote currency) because you believe one of the currencies will strengthen against the other.

How do you calculate FX options? ›

How is the cost of an FX option determined?
  1. FX option premium = intrinsic value + time value.
  2. Intrinsic value: The intrinsic value of the option is the difference between the amounts converted using the strike rate and the forward rate.

What is the number one mistake forex traders make? ›

One of the most common mistakes new forex trading make is not having a trading plan. A trading plan is a written set of rules that outlines a trader's entry and exit points, risk management strategies, and other important details.

When should I exercise FX options? ›

FX options can be classified based on the timing for exercise:
  1. European Option – European options can only be exercised at the end of the agreed tenor (at maturity).
  2. American Options – American Options can be exercised any time during the life of the contract.

How much do FX options traders make? ›

How much does a Fx Options Trader make? As of Apr 15, 2024, the average annual pay for a Fx Options Trader in the United States is $101,533 a year. Just in case you need a simple salary calculator, that works out to be approximately $48.81 an hour. This is the equivalent of $1,952/week or $8,461/month.

What is FX options with example? ›

In FX options, the asset in question is also money, denominated in another currency. For example, a call option on oil allows the investor to buy oil at a given price and date. The investor on the other side of the trade is in effect selling a put option on the currency.

What is the easiest way to explain options trading? ›

A call option gives the holder the right to buy a stock and a put option gives the holder the right to sell a stock. Think of a call option as a down payment on a future purchase. Options involve risks and are not suitable for everyone. Options trading can be speculative in nature and carry a substantial risk of loss.

Why do you need to learn FX options? ›

FX options can be a great way to diversify and even hedge an investor's spot position. Or, they can also be used to speculate on long- or short-term market views rather than trading in the currency spot market.

How are FX options settled? ›

Prior to expiration, traders have a number of options to either close out or extend their open positions without holding the trade to expiration. For those traders who want to take their contract to expiration, there are two ways an FX contract can be settled: cash settlement or physical delivery of the currency.

What do you receive when buying an FX put option? ›

There are two types of FX options – calls and puts. Buying a call option gives you the right to buy a currency pair while buying a put option gives you the right to sell a currency pair on the expiry date.

How do you hedge FX with options? ›

Forex options hedging strategy

A currency option gives the holder the right, but not the obligation, to exchange a currency pair at a given price before a set time of expiry. Options are extremely popular hedging tools, as they give you the chance to reduce your exposure while only paying for the cost of the option.

Why 90% of forex traders lose money? ›

The reason many forex traders fail is that they are undercapitalized in relation to the size of the trades they make. It is either greed or the prospect of controlling vast amounts of money with only a small amount of capital that coerces forex traders to take on such huge and fragile financial risk.

Why do 95% of forex traders lose money? ›

Absence of risk rewards skills

Many traders get in on bad trades. They don't understand enough about the market and just invest in believing that the market will eventually go up.

Has anyone gotten rich from forex trading? ›

One of the most famous examples of a forex trader who has gotten rich is George Soros. In 1992, he famously made a short position on the pound sterling, which earned him over $1 billion. Another example is Michael Marcus, also known as the Wizard of Odd.

Is FX option legit? ›

Fx Trade Options is not a trusted broker because it is not regulated by a financial authority with strict standards. We recommend you open an account only with brokers that are overseen by a top-tier and stringent regulator. All the 100+ brokers reviewed on the BrokerChooser website meet this criteria.

What is the difference between currency options and FX options? ›

Currency options are one of the most common ways for corporations, individuals or financial institutions to hedge against adverse movements in exchange rates. Corporations primarily use FX options to hedge uncertain future cash flows in a foreign currency.


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