Options: Pros and Cons

Major pro: buying options limits your exposure. The maximum you can lose is the value of the option, the price you paid for it.

Purchasing options as a speculative vehicle offers limited downside -- you cannot lose more than the price you paid for the option -- and unlimited upside, at least on a call. If you purchase a put, your profit is technically limited to the underlying currency going to zero.

The cost of the option may be less than the margin on the same spot position.

Major con: you pay for the time value of an option.

In spot FOREX, other than rollover charges (typically small), you do not pay for the time you hold a position.

Forecasting option pricing -- even given the price of the underlying currency -- is difficult.

If your option expires worthless, you lose your entire purchase price. This can occur from prices moving sideways and the time premium decaying to zero. If prices move sideways for the spot trader, he loses nothing and retains his margin funds. You may find prices of the currency moving in your favor but not fast enough to compensate for the time decay -- a discouraging predicament most options traders have experienced more than once. If the time on your option expires and the option is out of the money, its value is zero. (See Figure below.)

[caption id="attachment_13303" align="aligncenter" width="550"]The Downside of Options The Downside of Options[/caption]

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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