Note from Hugh: Today I am happy to present a guest post from my buddy at OptionsTradingIQ.com. Options is a market that I personally don’t have a whole lot of experience with and therefore do not blog about. So when he offered to do a post on how options could be used in currencies, I jumped at the chance to learn from him. I know a lot of Forex traders are interested in options as a way to hedge their risk, so check out this post…
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Forex trading is something I’ve always been interested in, but never taken the time to learn, or had the balls to try out. I’ve enjoyed reading Hugh’s blog though and maybe one day when I have more time on my hands (I have a two kids under age 3), I will try it out.
My passion is options trading. I’ve been trading for nearly a decade and tend to trade very conservatively. I aim for 1-2% returns per month trading credit spreads and iron condors. What do credit spreads and iron condors have to do with forex you might ask? Well, read on to find out.
Currently, I’m bearish on the Australian dollar. Commodity prices are falling which is a key factor in the performance of the AUD, and it’s likely interest rates are going to drop over the next year given the economy is slowing down somewhat. On a daily chart, we have a series of lower lows and lower highs signifying a new down trend is in place.
We have also broken below the 200 day moving average which I think will act as resistance. So, I will lay out a few different ways to use options to play a bearish opinion of the little Aussie battler (using the ETF FXA currently trading at 103.58).
Aggressive position – Long put
One idea, if you wanted to take an aggressive stance, would be to buy some FXA November 18th 102 Puts which are trading for around $1.70 or $170 per contract. The profit and loss on this position looks like this:
Max Gain – Unlimited
Max Loss – $170
Breakeven price – 100.30
Assuming that FXA moves back toward the lower trend channel and finishes around $94, you would make $6.30 or $630 per contract. This is calculated as (102 less 94 less 1.70). In this example, you need FXA to fall below 100.30 before you make a profit.
Conservative Position – Bear Call Spread (also known as a credit spread, as you receive a credit for placing the trade)
A Bear Call Spread is a conservative position, in that you are making a bet that the underlying will move by less than a certain amount. As an example, you could set up the trade like this:
Sell FXA November 18th 104 Call @ 1.80
Buy FXA November 18th 106 Call @ 0.95
For this trade, you will receive $0.85 or $85 into your account. The profit or loss on this position looks like this:
Max Gain – $85
Max Loss – $115
Breakeven Price – 104.85
If you’re unfamiliar with this option strategy, that may seem a bit confusing. Basically you will make the full $85 on this trade if FXA does not rise above $104. In the previous trade, we have a higher profit potential, BUT we needed the position to move in our favor. In this example, we made a profit even if the position moves slightly against us.
Iron Condor
Another options strategy that I use a lot is called an Iron Condor which is an income strategy. Let’s assume, that instead on being bearish on FXA, we have a neutral opinion and think it will be range bound between 100 and 104 over the next month. We could set up an iron condor by trading both a Bear Call Spread and a Bull Put spread such as this:
Bear Call Spread
Sell FXA November 18th 104 Call @ 1.80
Buy FXA November 18th 106 Call @ 0.95
Bull Put Spread
Sell FXA November 18th 100 Put @ 1.15
Buy FXA November 18th 98 Put @ 0.75
The net credit received for this trade is $85 + $40 = $125. The profit or loss on this position looks like this:
Max Gain – $125
Max Loss – $75
Breakeven prices – 98.75 and 105.25
These are a couple of different ways you can play the forex market using options, but there are many, many more. That’s the great thing about options, there is so much flexibility.
What do you think of these strategies?
If you have any questions or comments, leave them below and I will respond.
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About the Author: OptionsTradingIQ.com is dedicated to helping beginning options traders succeed. You can also follow them on Twitter: @OptiontradinIQ
