Q1. What do you understand by Options in FOREX market? Explain the types of Options.

Instructions

To explain Forex Options, it's important to explain what an option is. An option is a contract which gives the buyer (known as the owner) the right, but not the obligation, to buy or sell an underlying security at a fixed price within a specified time frame.

An underlying security could be currencies, stocks, commodities and indices. It is the item which is being traded. This fixed price is the price at which a security is bought or sold at - in currency option trading it is known as the strike price.

There are two types of option strategies: Call and Put.
In a call option, the owner may buy a quantity of an underlying asset at the strike price within a specified time frame.
The buyer of a call option believes the market price of the asset will rise above the strike price. If this happens, then the option (or contract) allows the owner to buy the asset at the strike price which is lower than its current price. This means the asset can be bought below its market value and the owner can profit from the difference.
In a put option, the owner may sell a quantity of an underlying asset at the strike price within a specified time frame.
The buyer of a put option believes the market price of the asset will fall below the strike price. If this happens, then the option allows the owner to sell the asset at the strike price which is higher than its current price. This means the asset can be bought below its market value and the owner can profit from the difference.

There are several benefits of forex option trading which is why many investors favor it over other options: the risk is limited to the amount purchased in the option an investor can pay less money to enter into a deal and the possibility of profiting is high the risk is known from the offset, since the maximum an investor can lose is the money he deposited for the trade.

However, once an option has been bought, it cannot be sold so the decision to trade is final. Also, it is difficult to predict the market so an investor must be careful and considerate when trading options.

Initially, currency trading was only accessible to wealthier customers who could afford to trade with large quantities of currencies. However, due to the introduction of online trading platforms, such as anyoption™, profiting from currency option trading, even for small investors, is possible and achievable. Online option trading also enables people to invest whilst in the comfort of their own home. They can trade from wherever they are geographically, without the need for a broker.

Types of Options

American Option

This is an option that can be exercised at any time up to and including the expiry date. There are no general formulas for valuing American options, but a choice of models to approximate the price is available (for example Whaley, binomial options model, Monte Carlo and others), although there is no consensus on which is preferable.

American options are rarely exercised early. This is because all options have a non-negative time value and are usually worth more unexercised. Owners who wish to realize the full value of their options will mostly prefer to sell them rather than exercise them early and sacrifice some of the time value.

European Option

Europeans Options can only be exercised on the expiry date. European options are typically valued using the Black-Scholes or Black model formula. This is a simple equation with a closed-form solution that has become standard in the financial community

Options Delta - DefinitionOptions Delta measures the sensitivity of an option's price to a change in the price of the underlying stock. Options Delta - IntroductionIn layman terms, delta is that options greek which tells you how much money a stock option will rise or drop in value with a $1 rise or drop in the underlying stock, which also translates to the amount of profit you will make when the underlying stock rises. This means that the higher the delta value a stock option has, the more it will rise with every $1 rise in the underlying stock. Stock options with options delta of 0.7 is expected to rise $0.70 with a $1 rise in the underlying stock. Stock options value is affected most by changes in the price of the underlying stock, making delta value of stock options the single most important options greeks to understand in options trading. |

Characteristics * Positive & Negative Options Delta Values:Options delta values are either positive or negative. Call Options have positive delta values suggesting that it will gain in value proportionately with a gain in value in the underlying stock. Put Options have negative delta values suggesting that it will lose value as the underlying stock rises. Conversely, call options with its positive delta values drops in price as the underlying stock falls and put options with its negative delta values gains in price as the underlying stock falls. In short, positive delta value becomes profitable as the stock goes up and negative delta value becomes profitable as the stock goes down. * Options Delta & Options Moneyness:Options delta value rises as options gets more and more In The Money (ITM) and reduces as the options gets more and more Out Of The Money (OTM). At The Money Options, no matter call or put options, have delta value of 0.5, suggesting a 50% chance of either ending up In The Money or Out Of The Money. Learn about Options Moneyness now.

* Options Delta & Time to Expiration:When there is lesser time to expiration, the chances of options staying in their prevailing state of moneyness by expiration increases. This means that the nearer to expiration an option is, the more likely it is that in the money options will stay in the money by expiration and out of the money options staying out of the money by expiration. As such, the nearer to expiration, the higher the options delta value of in the money options would be and the lower the delta value of out of the money would be at the same strike price.