There are options on virtually all markets, including Forex. Trading Forex options generally entails less risk than trading Forex outright, but there are drawbacks as well. Investors may trade Forex options exclusively, or use options to implement additional strategies when trading Forex.
Definition
A Forex option is a contract that lets an investor buy or sell a currency at a fixed exchange rate for a set period of time. Forex options are traded over several exchanges and they constitute a separate market apart from the Forex market. The prices or premiums of Forex options vary based on the characteristics of the options and underlying Forex exchange rates.
Types of Options
As with other options, Forex options are divided into calls and puts. A call option is an option to buy a currency pair, while a put option is an option to sell a currency pair. For example, if an investor expects the euro to rise against the dollar, he should buy a call option on the eurodollar pair (EUR/USD). If he expects the dollar to rise against the euro, he should buy a put option on the eurodollar pair.
Pros
Options allow Forex investors to lower risk. When an investor buys an option, the most she can lose is the premium paid for the option. However, in the Forex market, it is possible to lose more than the initial margin deposit on a trade. Options are useful for capturing moves in the Forex market without taking on the risk of a large loss.
Cons
The main drawback of options is their limited lifespan. When trading Forex, investors can hold positions as long as they want provided that losses don't take them out of the market. Forex options must be sold or exercised before they expire and they may expire worthless if the underlying currency pair doesn't move in the investor's favor.
