Winning in Todays Hottest Marketplace_10

Part Extra for Experts Chapter Options and Exotics t the Interbank level, options have been an integral part of the FOREX landscape for many years. It is estimated that options may comprise up to 10 percent of FOREX market share, a substantial portion for hedging purposes by banks and corporations. A bank may be at risk on an international loan for a short period of time. Hedging with currency options can eliminate that risk. Hedging acts as an insurance policy. If the bank is at risk on the long side of the EUR/USD, they can take the opposite position in options. A corporation might do the same while awaiting payment on a large sale. Loss on the business-side transaction is compensated by a profit in the hedge. For retail currency traders, speculative options trading has been the domain of seedy boiler-room operations until recently. There are now three domains in which you may trade currency options: (1) Two exchanges trade listed currency options; (2) you can spread-bet currency options at any of the spread betting operations mentioned in Chapter 13, “The FOREX Marketplace”; (3) several reputable retail broker-dealers now offer FOREX options on 10 or more pairs and with a wide variety of features. I now recommend traders who wish to work with currency options use a retail FOREX broker. The advantages and convenience of being able to trade spot FOREX and the corresponding FOREX options under one roof is substantial. Exotics, currency pairs with the USD or EUR, and a small or exotic coun-try’s currency provide exceptional opportunities along with higher risks than the majors or top-tier crosses. They offer variety, have trading personalities all their own, and may be especially attractive if you have some knowledge or insight about the exotic country other traders do not. 247 248 EXTRA FOR EXPERTS Options Options are not a simple investment vehicle and the terminology can be confusing. Options can be used for speculation—to make a profit—or as a hedge— to protect a position maintained in the normal course of one’s business. If you hedge a speculative spot FOREX position with options, it is considered a spec-ulative hedge. It is only a true hedge if you are protecting a legitimate business transaction involving currency risk. For speculation, options can be used as either a trading instrument or as a money management tool paired with spot FOREX trading. I strongly advise new traders to become fully comfortable in the spot FOREX space before considering options. Because of the additional time value component, the matrix of possibilities and strategies can be enormously com-plex and mathematically heady. In options time is not on your side. It is a constantly deteriorating (decay-ing) value. The price of the underlying currency must not just move in your favor to make money; it must move enough to compensate for the time decay. Every options trader has experienced this: The call is due to expire soon and suddenly the underlying vehicle (a stock, a commodity, a currency pair) begins to move up, sometimes dramatically. But the option is decaying even faster than the underlying vehicle is going up. The result: The price of the option continues to go down. In the meantime, the buyer of the spot pair has made a tidy profit. An Options Primer An option is the right to buy or sell the underlying currency at a specific price for a specified period of time. You can purchase an option or write an option. For speculative purposes, purchasing is most common. The right to buy is a call. You have the right to call the position away from someone holding the spot equivalent. The right to sell is a put. You have the right to puta spot position to someone. You purchase a call if you believe the currency price is headed up. You pur- chase a put if you believe the currency price is headed down. An option is a con-tract between a buyer and a seller; the seller is termed the writer, the buyer is the purchaser. Basic Options Terms The strike price is the price at which the call or put may be exercised. It does not make sense to exercise a call or put (exchange it for a spot position) unless Options and Exotics 249 the call or put is in-the-money—trading above (call) or below (put) the strike price. You may, of course, offset your option, buying it back (a put) or selling it (a call) before the expiration or even if it is not in-the-money. You have effectively transferred your contractual obligation to someone else. You might purchase a call out of the money and sell it out of the money and still profit thereby. The expiration is the time frame of the option. In stocks and commodi-ties, these are normally set for months. An option is said to expire in September, for example. In FOREX the expiration dates are closer since very few traders hold positions for months at a time. The premium is the cost of the option. With options you are paying for the time-value as well as the price values. The underlying value of the option falls as time approaches the expiration—unless the price value increases at a faster rate. Options pricing, because of these twin values, can be complex and unpredictable. You can be correct on the price direction and still lose money because of decaying time values. The intrinsic value of an option is what it is worth if exercised at any given time. When an option is out-of-the-money its only intrinsic worth is time value. A call is in-the-money if the spot price is above the strike price; out-of-the-money if below. A put is in-the-money if the spot price is below the strike price; out-of-the-money if above. The price of an option, or premium, is determined primarily by strike and expiration vis-à-vis the current price of the underlying currency. But there are other factors such as liquidity, speculative fervor, and volatility. For example, an out-of-the-money call is more valuable if the underlying currency is volatile; it has a better chance of going to in-the-money. Forecasting option prices—even knowing or inputting the price of the underlying currency—is far from an exact science. A small change in time value or price value may cause the option price to change by an inordinate amount. The various price factors appear to interact in a nonlinear fashion. Mathematic whizzes will find a similarity to the famous n-body problem. A vanilla option is one with only the basic components of expiration date and strike price. An exotic option contains complicated features and complex payoffs that often are determined by outside factors. Exotic options are mathe-matically complex; going to the moon was easier than predicting exotic options in the author’s humble opinion. Traditionally, currency options have been of two types: American-style: This type of option may be exercised at any point up until expiration. European-style: This type of option may be exercised only at the time of expiration. ... - tailieumienphi.vn