Fundamentals of Foreign Exchange Options
One of the best alternatives in currency trading is Forex Options. From the name itself, it illustrates every trader's need in managing foreign exchange markets. With forex options, two traders establish a contract consisting of financial agreements. These are the date of expiration, price, and the entities involved.
Like any methodology, learning the basics is essential prior to manifesting strategies for effective application. Below are prominent tools in Forex options:
Buyer - is the entity that holds the right in selling the currency on or before the expiration date. The buyer can also constrict the contract until its expiration or establish a position in the foreign currency market. If the buyer takes the position in the "spot" market and chooses the forex option, the buyer takes the "assignment."
Because the buyer is one of the financial contract entities, he also has an obligation to fulfill, which is paying the premium price. This usually occurs upon the seller's currency offer. After paying the premium, the buyer needs only to wait the expiration date.
Seller - also known as the "writer" or "grantor" of contract, the seller usually becomes the opponent of the buyer when it comes to the spot position. This begins after the buyer pays the premium. After collecting the payment, this will be deposited in the seller's account. The amount collected will be the fund for covering the margin requirement. Commonly, this requirement is for the currency trade itself. Without it, currency trade would not occur.
The duty of the seller is to observe for market movement. Whenever the market moves negatively, the seller would have to add funds in order to retain its position within the market. Posting funds after a negative trend prevents the margin requirement to decrease below the foreign exchange option account.
Parallel to the role of the buyer, the seller has the choice in retaining or selling the financial contract before the expiration date.
Volatility - is the most significant aspect in forex options, as this assesses the price movement in forex options. If there were an increase in volatility, chances would be high in terms of contract expiration. In addition, this increase indicates higher risk for the foreign exchange seller, who begins to demand a bigger premium payment.
Delta - is the indicator of price change in terms of the spot rate. Usually, there are many factors affecting such price change. For one, there is volatility. If there is change in volatility, there is also change in delta. Second would be the interest rate and finally, the expiration date. If there are only months or weeks to count before expiration data, it is appropriate to expect change in delta.