What Are 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 speculative 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 complex and mathematically heady.

In options, time is not on your side. It is a constantly deteriorating (decaying) 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.
By Michael Duane Archer
Michael Duane Archer has been an active futures and FOREX trader for more than 35 years. He has worked in various advisory capacities, notably as a commodity trading advisor, registered SEC investment advisor, and branch manager for Heinold of Hawaii. He currently trades FOREX and futures and is involved in several technical analysis research projects.

Copyrighted 2016. Content published with author's permission.

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