Most people, especially those who do not do much currency trading, think that the term Forex is a catch all term for any trading involving more than one currency.  The get rich in literally minutes appeal of the Forex market has definitely gained a lot of attention.  In many ways it has eclipsed other types of trading such as currency options trading, which are more important to the global economy.  These types of trades help global businessmen reduce their risk when facing the quick and often unpredictable changes inherent in the Forex market.

How Does Currency Options Trading Work

Currency options trading is like future insurance.  The Forex market is traded live, but business deals and the major factors that determine currency value take time to develop.  That’s where currency options come in.  A currency option is basically the chance to trade a certain amount at a certain exchange rate on a certain day.  Buying a currency option allows a person to in effect set a maximum cost for a currency transaction.  For example, let’s say that a European has agreed to sell his house to an American for 150,000 Euros.  The American is flying to Europe to pay and take possession of the house a month from today.  The American has checked his bank account and the exchange rate and knows that as of today he has enough money, but if the exchange rate moves even by a penny the effective price of the house changes by over $2,000.  He is likely to buy a currency option that will effectively allow him to trade the money in his bank account at today’s exchange rate for 150,000 Euros.  That way, he knows that he will have enough money to buy the house no matter what the exchange rate does in the next month.  Buying the option doesn’t lock him in to today’s rate, so he can save thousands on his house if the exchange rate moves in his favor, and use the money “saved” on the house to install a video surveillance system.

Currency Options as an Investment

The example also demonstrates the obvious necessity of currency options in international business dealings, but currency options trading can also be used in conjunction with the Forex market as an investment.  Instead of investing money directly into a currency pair, a person could buy a currency option on it.  He could wait until it was time to go through with the option to see if fulfilling the option and then turning around and trading back would make a good profit.  The cost of the option will cut into his profit, but it will also protect him from losing money if he would have lost by investing in a weakening currency.

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There are several advantages of online options trading compared to investing in individual stocks. While most options trading strategies have a short term focus, there is the potential for huge returns. Whether the stock market is bearish or bullish, an options investor can find opportunities to create a profit.

Investors looking to maximize their returns in a volatile market should strongly consider online options trading. With the proper education, the advantages far outweigh the risks of this type of trading strategy.

Reasons to Start Online Options Trading

Here are three specific advantages online options traders have over investors who strictly trade stocks.

1. Low Initial Investment – The total out of pocket costs from online options trading is much less than purchasing stocks. Many new investors avoid certain stocks because they cannot afford to initiate a sizeable position in a stock. For example, purchasing 100 shares of a $100 stock would cost $10,000. Instead of purchasing 100 shares of a stock, an investor could buy 1 call contract which represents the same amount. Buying a call contract for the stock would cost only a fraction of the price it would take to purchase the stock outright, leaving the investor room to make other investments. The price of the call contract will vary depending on the expiration date and strike price.
2. Return on Investment – Since option prices follow the same direction as the underlying stock, the return on investment is much higher. Since investors spend much less on opening an option position than they would with the actual stock, the return is greater. For example, a $1.00 increase in the stock would result in a gain of $100 on a 100 shares. The same increase in a call option would equate to the same $100 profit. The big difference however is the amount of the initial investment when comparing the 100 shares versus the 1 call option contract. Since the initial upfront cost of the option will always be much less than that of the underlying stock investment, the return on investment for the option is greater.
3. Investment Choices – Online options trading offers many different investment opportunities for any kind of market. Bullish investors can purchase call options or sell puts on particular stocks they believe will be rising. On the other hand, a bearish investor can buy puts or sell calls against stocks they think will be decreasing. There are also plenty of option trading strategies that use a combination of calls and puts that can profit from a movement in a stock in either direction. With so many different ways to profit, it is no wonder online options trading has become a popular way to invest.

Final Thoughts

Online options trading has many advantages over investing directly in stocks. No matter what kind of market trends are occurring, an options trader can find a way to generate profits. With the numerous investment choices, low initial investment, and huge returns on investment – trading options can be a great opportunity for investors.

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A short explanation of stock options is easy enough to obtain on the Internet, but once you get the concepts understood, you should be aware that this is one game where understanding the rules doesn’t necessarily increase your chances of success. Stock options are useful for adding some leverage into your portfolio, but should only be bought with a very small portion of your investment funds-say 5% or less-and only when you have paper-traded options for some time.

What is the difference between buying shares in a company and buying put or call options on those shares? Maybe an example will help: if I buy 100 shares of XYZ at $30 I will pay $3000, and if the price of the shares increases to $33 per share, I make 10% on my money when I sell, whether it takes two weeks or five years for this to happen.

With options things are a lot more complex. A call option gives us the right to purchase 100 shares of XYZ at a given price, by a given date in the future. The fact that this right expires by that date means that the value of the right, or the option, will be deteriorating as the value of that time remaining dwindles. If by expiration the price of the stock is below the “strike price”, the price at which we have the right to purchase the shares, then obviously the right to buy the shares at the strike price will be worth nothing, since we could simply buy them for less on the open market. For this reason, it is possible to lose your entire investment when purchasing options.

On the other hand, let’s say that we pay $200 to buy an XYZ option with this $30 strike price with one month remaining before expiration. And if by expiration of stock rises to $33 as in our example, we know that the value of our option will be $300 (100 shares times three dollars above the strike price). In this case we could very quickly make a 50% gain on our investment.

I have tried to sketch out in very simple terms just why options are so risky, as well as how easy it is to make quite a lot of money quickly, relative to the amount that you invest. The best advice I can give you is to be extremely careful in trading options through online brokers that tempt you with the possibility of huge profits. Educate yourself first. This is an online business games that is extremely risky and unforgiving, with real financial consequences!

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