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Options have an expiry date, beyond which they cannot be exercised. The premium consists of the intrinsic value and the time value (e.g., the more in the money it is, and the more distant expiry, the more valuable). Another important element in option pricing is volatility. The higher the implied volatility (and therefore probability of the option ending in-the-money (ITM), the higher the premium will be. The topic of option pricing is very complex, and it was only after Black-Scholes-Merton (BSM) created their model that option pricing gained objectivity (if not accuracy- there are many unrealistic assumptions in their model).

The BSM model uses 5 main variables which they named from the Greek alphabet- three of which are very

important:

Delta- how the option value changes as the underlying

Gamma- the first derivative, or velocity, of Delta

Theta- how fast the option loses value with time,

Vega- what effect a change in the underlying volatility affects the option value,

Rho- interest rate effects) is less important to traders, having only a second degree effect on option value.

Options and Forex- a perfect marriage

The usually high volatility of Forex lends itself very well to options. Once an option is in the money (ITM), the

value moves nearly 1:1 (excepting the time value) with the spot. Our downside risk is limited to the premium

already spent (if we avoid being net short options). No further drawdown to your account is possible. No matter

what the spot does, we can sleep at night.

Another advantage is that the need for stops is moot- if the spot moves away from the strike, the option value

drops. However, as long as there is still time value, if the spot recovers, so does the value of the option. This is a

key advantage of options- short term price action does not imperil our equity.

1) Choosing the Strike Price

We can buy ITM, ATM or OTM options. Generally, if the option is ITM or close to it, you’ll pay for excess

delta- but a higher probability of finishing ITM. We must integrate multiple factors for this decision. First, is the volatility high enough? Second, are there underlying fundamental changes that will drive it to some level (say to Purchasing Price Parity), and Thirdly, mean reversion.

2) Choosing the Expiry date

Obviously, the more distant the expiry, the more probability of profit (but you will pay for the excess theta).

To maximize your profitability (or minimize the loss if the option expires worthless), at a minimum, we

should calculate and analyze our estimate of the future volatility of the underlying, to determine if there is

a good chance for the spot to move far enough to make the option ITM.

Why Forex?

Accessibility :It is no wonder that the Forex market has the trading volume of 3 trillion a day all anyone needs to take part in the action is a computer with an internet connection.

24 Hour Market: The Forex market is open 24 hours a day, so that you can be right there trading whenever you hear a financial scoop. No need to bite your fingernails waiting for the opening bell.

Narrow Focus : Unlike the stock market, a smaller market with tens of thousands of stocks to choose from, the Forex market revolves around more or less eight major currencies. A narrow choice means no rooms for confusion.

Liquidity : The foreign exchange market is the largest financial market in the world with a daily turnover of just over $3 trillion! Now apart from being a really cool statistic, the sheer massive scope of the Forex market is also one of its biggest advantages. The enormous volume of daily trades makes it the most liquid market in the world, which basically means that under normal market conditions you can buy and sell currency as you please.

Profitability: It doesn’t take a financial genius to figure out that the biggest attraction of any market, or any financial venture for that matter, is the opportunity of profit. In the Forex market, profitability is expressed in a number of ways. First of all, just to set the record straight, you don’t have to be a millionaire to trade Forex. Unlike most financial markets, the Forex market allows you to start trading with relatively low initial capital.

Cashing in on Price Movements : Trading Forex is exciting business. The market is always on the move, and every tiny shift in currency rates can mean profits and losses of hundreds and even thousands of dollars!

In general, the eight most traded currencies on the Forex market are:

U.S. Dollar,Euro, British Pound, Japanese Yen, Canadian Dollar, Swiss Franc, New Zealand Dollar, Australian Dollar.

Forex trading is always done in pairs, since any trade involves the simultaneous buying of a currency and selling of another currency. The trading revolves around 18 main currency pairs. These pairs are:

USD/CAD EUR/JPY

EUR/USD EUR/CHF

USD/CHF EUR/GBP

GBP/USD AUD/CAD

NZD/USD GBP/CHF

AUD/USD GBP/JPY

USD/JPY CHF/JPY

EUR/CAD AUD/JPY

EUR/AUD AUD/NZD

When buying or selling a currency pair, each pair has its own Bid/Ask rate, for example:

Pair Bid Ask

EUR/USD 1.5420 1.5422

BASIC FOREX TRADING GUIDE 6

This means you could either:

Buy the pair at the Ask rate

Which means:

Buy 1EUR / Sell $1.5422

Sell the pair at the Bid rate

Which means:

Sell 1 EUR / Buy $1.5420

OK, but where is the opportunity for profit?

The rates of currency pair are constantly changing. One profitable way is to buy a pair, and sell it at a higher rate and another way is to sell the pair and buy at a lower rate.