Forex options are option contracts which have the Forex’s market currency pairs as the underlying asset. As a trader, you can consider either two basic options: the basic call or put option, or the SPOT option which stands for “Single Payment Options Trading”. An example of a SPOT option is a binary option.
The basic call and put Forex options give you only the right but not the responsibility to either buy or sell a currency pair at a particular exchange rate at some pre-agreed upon time in the future. As with other options, if the Forex options are out of the money, they will expire worthless. When you the trader puts on a trade there is the simultaneous buying of one half of the currency pair while the other half is sold. Thus all Forex currency pairs have a “base” currency, the left number, and a “quote” currency which is the right number. If you buy a currency, you then buy the base currency and sell the quote currency. Note that the quote currency’s numerical value tells you how much of that currency is required to buy one (1) unit of the base currency. If you sell a currency, you buy the quote currency and sell off the base currency.
As with any options, when you buy a contract there is a premium paid by the buyer, a strike price, and an expiration of the contract. If the market price moves past the strike price, then you earn a profit determined by how many “pips” past the strike price for the option has moved. With this feature, there is a powerful but dangerous leveraging, i.e. a small price movement in relation to a position, bought for a small premium can yield to substantially large profits. On the other hand there is risk too because the premium invested could be lost if the option expires worthless and out of the money. By guessing correctly, your net profit is earnings minus the premium paid.
SPOT Forex options are a bit different as these come with higher premiums compared to the standard call or put Forex options. Also, they are easier to set and execute because pip movements past the strike price are completely irrelevant. Instead you, as the trader, make a calculation about a desired outcome essentially guessing on how far away, and in which direction, from the current price of a Forex pair will be the currency pair at a set time in the near future. This time frame could be from a few hours, a day or two, or even a week from now, but whatever time is chosen, it must be in the near future. Based on your calculations, the broker quotes the premium price based upon your parameters. If you pay this premium and buy the contract, you will either hold it until expiration or sell it to “close” for a profit. If at expiration the strike price has been touched or broken through by any number of pips, you will be paid the pre-agreed upon flat pay-out for a profit. If your assumptions were wrong, the option expires worthless and you lose your premium.
Binary Forex options are the simplest of the SPOT options to set and execute. Their affordability and ease of trading have made binaries popular. The North American Derivatives Exchange, NADEX, is an exchange where binary Forex options are traded. The exchange quotes and facilitates trading, and there you can purchase contracts for about $20 premiums with $100 pay-outs for correct bets. Binary Forex options have become well known for their power as hedge trading also which can provide portfolio insurance in the event a previous planned trade fails. The hedge position can be in the form of multiple offsetting positions. The hedge with binaries is also in the form product performance because direct retail trading of currencies requires stops which may not be executed in time due to the market’s volatility. Market makers may be sloppy in executing stops resulting in larger losses than the trader anticipated. So many experienced Forex traders use binaries as hedges which gives depth and liquidity to the overall binary market. This means better trading for you.