Currency options, or forex options, are contracts that give the purchaser the ability to purchase foreign currency from the exchange at a specific price on or before a specific date. Like stock options, there are two different types of foreign currency options: A call option gives the holder the right to buy currency at a specified price (the strike price), while the holder of a put option can sell a currency at a predetermined price.
Companies or those investing in foreign countries often use forex options trading as a way to hedge against unfavorable fluctuations of foreign currencies or to speculate on volatility.
What Are Currency Options?
Like options in the stock market, currency options are a derivative instrument. In this case, the underlying asset is a foreign currency pair. Currency options trading involves buying one type of currency and selling another. Foreign exchange options are a way to invest in foreign currency markets without trading in the actual currencies themselves.
How Do Currency Options Work?
If you understand how to trade options in the stock market, currency options work in a similar manner. Buying a currency call option gives you the right (but not the obligation) to purchase a particular foreign currency at a specified price (the strike price) at any time before its expiration date. A currency put option works in a similar way, except that the buyer has the right to sell a currency at a given price before the expiration of the option.
You can also purchase combinations of both put and call options at different strikes and/or different expiration dates, depending on how you think the market will move. If you don’t want to own the currency itself, you can always close out your position before the options expire. Doing so gives one exposure to movements in the exchange rate without having to actually purchase the currency.
Pros and Cons of Currency Options
Here are some of the pros and cons of currency options:
| Pros | Cons |
|---|---|
| Using currency options is a low-cost way to hedge against adverse currency moves | The price of currencies can be extremely volatile |
| Provides more leverage allowing for potentially higher profits with less money invested. | Currency markets are controlled by local governments which can increase risk |
| You have many different ways to trade depending on your market outlook | Usually less liquidity than currency trading itself |
Vanilla Options
The most basic currency options come in two types: calls and puts.
Currency Calls
A currency call option gives the holder the right to purchase a given currency at a specific price, any time on or before the option’s expiration date. You would generally buy a currency call option if you have a bullish outlook on a particular currency.
Currency Puts
A currency put option works in the opposite manner to a currency call option. If you hold a put option, you have the right (but not the obligation) to sell a specific currency at a particular price before the options expire. Purchasing a put option is something that you would do if you have a bearish outlook on the underlying currency.
SPOT Options
Another type of currency option is single payment options trading (SPOT). With a SPOT option, an investor and broker can set more detailed conditions for the option to pay out. Because there are only two possible conditions upon the option expiring, these options are sometimes called binary currency options.
The Takeaway
Currency options can be a way for you to invest in the foreign currency market without actually owning the foreign currency itself. You can use call options, put options or a combination of them based on how you think the market will perform.
Whether you’re new to options trading or simply in the market for a new platform, SoFi’s options trading is worth a look. Its intuitive and approachable design allows gives the ability to trade options from the mobile app or web platform. And if you need a refresher on any info, there’s a library of educational resources about options to access.
FAQ
What are some types of currency options?
The two main kinds of currency options are call options and put options. A call option allows the holder to buy the specified currency at a given strike price, while a put option allows the holder to sell a given currency at a particular price. There are also SPOT or binary currency options.
What is a currency call option?
A currency call option allows the holder to buy a specific currency at a specific price, on or before the expiration date.
How are currency options settled?
If you hold a currency option that is in the money at expiration, there are two possibilities for settlement. You can settle the option with cash or by a physical delivery of currency. If you are short an in-the-money option at expiration, you may need to deposit cash into your account to settle your account.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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