Higher Return Risk from Forex using Options

by Paul Stafford

Paul Stafford from www.4xtradertool.com explores the advantages and some strategies related to currency options trading.

In this paper we review common methods of trading the Forex markets, and examine a new method, using Forex options, which offers several significant advantages over traditional methods. In this paper, I assume a basic knowledge of trading the Forex spot market.

Trading the Forex market in any manner has many advantages over other markets (such as equities). It is highly liquid, very large, almost impossible to manipulate, its volume driven mainly by commercial trade need (not speculation), and the relevant data is transparent and easily available (except trade volume). However, there are some real pitfalls. If we’re wrong directionally and the market finds us, losses can be severe, even at lower leverages. A modicum of volatility is good for trading, as movement is what sustains a market. However, during the last year volatilities have been enormous. With a 24/5 market, you can’t always be there to monitor positions. The use of stops can prevent a blown account, but they also lock in losses, sometimes needlessly.

As we will see, trading Forex with options preserves much of the advantages of trading Forex, and eliminates some of the downsides:
There is no leverage in the purchase of options. Sleep at night.
There is no drawdown beyond the premium. Sleep at night.
There is less time involved (no need to monitor positions often).
Trading with options avoids the paying of interest on leveraged positions- of special interest to Muslim investors following Sharia law, who cannot pay interest (or even receive it on the Carry).

The upside is large and can return multiples of the premium. The two disadvantages to options are 1) unlike a trade in the underlying asset, options are time-limited and 2) the spot must move enough to cover the premium and then an additional amount for a profit to be made. A trade in the underlying spot profits as soon as it moves enough to cover the broker spread. We will see that both of these factors can be accounted for and calculated so as to maximize the probability of returns.

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