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When speaking about options trading, people usually think of stock options. However, options can also be applied to other financial instruments such as commodities, bonds, or even currencies. Options have in fact become an alternative investment of choice for many investors and traders, corporate or individuals, for hedging their funds. When used in Forex Trading online forex trading, options allow traders to increase their gain and limit their risk. In fact they allow the Finotec is one of the few online forex brokerage firms to offer options on the main currency pairs.
To understand what options are, think of them as a type of insurance policy: they are effective and valid only if certain conditions are met.
Forex option definition:
A forex option is a contract between a buyer and a seller under which the buyer has the right – but no the obligation – to sell (or buy) a specific amount of one currency against another at a predetermined price and on or before a preset date in the future. In return for this right, the forex option buyer will have to pay a one-time sum, called “premium,” to the seller.
The rights and obligations of buyer and seller:
The party buying the currency options contract (also known as buyer or “holder”) may choose to either sell it before its expiration date or keep it until its expiration date. In this case, the buyer exercises his/her right to take a position in the underlying spot exchange rate. On an online trading platform, as soon as the buyer takes this position, the position is automatically closed for immediate payout. If the market moved in his favor, then he takes in the difference between the market price and the strike price. If the market moved against him, the position is just closed – he has already paid the premium.
The buyer’s only financial obligation is thus the premium he must pay to the seller. On the expiration date, a CALL buyer may exercise his/her right to buy the underlying spot position at the strike price while a PUT buyer may exercise his/her right to sell the underlying spot position at the strike price. However, buyers often sell the currency options contract before the expiration date. There is no limit to the possible profit of the buyer.
If the buyer exercises his right, the party selling the currency options contract (also known as seller or writer) is obligated to take the opposite underlying exchange rate spot position. The idea is that the premium paid by the buyer will cover the risk in case the seller is forced to take an adverse position on the underlying spot market.
Read more about Forex option trading on www.forex-tradingtraining.com
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