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Forex Option Trading is available to trade on our own fully integrated Trading Platform – IKON Prodigy.

Option Types

Call Option
A call option gives the buyer the right to buy (go long) a spot currency pair at a specific price on an expiration date. For example, a EUR/USD 1.25 call option expiring on September 15th gives the buyer the right to buy or go long spot EUR/USD @ 1.25 on September 15th. Even if spot EUR/USD goes well past 1.25, the option buyer retains the right to own the underlying spot position at 1.25 on the expiry date. Of course, the option buyer may close the option prior to the expiration.

Put Option
A buyer of a put option has the right to sell (go short) a spot currency pair at a specific price on the expiration date. For example, a EUR/USD 1.20 put option gives the put buyer the right to sell EUR/USD @ 1.20 on the expiry date of the option. Should spot EUR/USD go well below 1.20, the put holder (buyer) still retains the right to go short at 1.20.

Trader Types

Option Buyer
The buyer, or holder, of an option can choose to exercise his right and take a position in the underlying spot currency. On the expiration date, the call buyer can exercise his right to buy the underlying spot position and the put holder can exercise his right to sell the underlying spot position. Should the buyer choose to exercise his rights on expiration, he will be assigned a spot position equivalent to the strike price and notional amount. In most cases though, the option buyer does not exercise, but instead offsets the option in the market before expiration, if it has any value.

Option Seller
Option sellers (i.e., those who sell options that they didn't previously own) are also called option writers or grantors. The seller could be a trader or hedger and is contractually obligated to take the opposite spot position if the buyer exercises his right. In return for the premium, the seller assumes the risk of taking a possibly adverse spot position. Puts and calls are separate option contracts; they are not the opposite side of the same transaction. For every put buyer there is a put seller, and for every call buyer there is a call seller. The option buyer pays a premium to the seller in every transaction. Options are often thought of as difficult to learn –requiring numerical ability beyond most people. Actually, options are not difficult to understand once the basic vocabulary is mastered. Only the very advanced options concepts and strategies require any complex mathematics.

Factors Affecting Option Prices

Intrinsic Value and Time Value
The price of an option consists of two parts, the intrinsic value and the time value. The intrinsic value is defined as the difference between the strike price and the underlying FX spot rate (American style) or FX forward rate (European style). It represents the value if exercised. For example a European call option with a strike price of 1.50 GBP/USD and spot at 1.60 GBP/USD on the expiry date would have an intrinsic value of 0.10 USD. Therefore the buyer would certainly exercise the option. However, the value of an option during its whole lifetime will always be above the intrinsic value. This value represents the uncertainty until expiration, the risk of the Underlying asset and the riskless return of the currencies. The following factors are included in the time value: 1. The spot price of the currencies 2. The strike price of the option 3. The riskless interest rate of both currencies 4. Time to maturity 5. The volatility between the involved currencies. Volatility is without a doubt the most important factor of the above mentioned. It is a measure of movements in the price of the underlying. A high volatility increases the risk of the option and the uncertainty about future price movements, but increases also the probability that the option is in the money at expiration. Therefore an increase in volatility causes an increase in the option price of both call and put options. The proportion of time value as part of the option price is not always the same over the life of the option. The time value decays at an accelerating rate towards maturity with little decay at the beginning of longer-term options. Therefore buying a longer-term option would give a better value than purchasing an option with a shorter maturity. The premium is higher as well. The time value also depends whether the option is in, at or out of the money. At the money options have the highest time value because the uncertainty of moving into the money and therefore for exercising the option is very high (50:50). The expectation about movements of in the money and out of the money options are more certain, resulting in lower time values.

Implied Volatility
Implied volatility is the volatility that the market assumes for a current option price. It can be determined as value that has to be input into an option price model (e.g. Black-Scholes) in order to generate the current market price of the option. Implied Volatility can be used as a measure for the valuation of an option or of how market participants expect the exchange rate to fluctuate in the future. Basically implied volatility will give the price of an option; historical volatility will give an indication of its value.

Delta
The delta of an FX option is the change in price of an option, relative to a change in the foreign exchange rate. Any change in a factor that can influence the potential exercise, causes a change in the delta as well. This could be a change in the underlying FX rate, in the volatility, riskless interest rate or passing time (see in table one how these factors influence the option price). The delta of an at-the-money option is always 50% because the probability of exercising is 50:50. Deltas for in the money and out of the money options have to be calculated but generally a deeply out of the money option will have a delta very close to zero and an in the money option will have a delta very close to 1. The above material was compiled from the best available resources including public information from the Chicago Mercantile Exchange and the British Bankers Association. IKON GM makes no representations as to the contents veracity or accuracy. As with all financial products, it is important to educate yourself with as much available information as possible.

Review
• Option Buyer
• Pays premium
• Right to exercise, resulting in long spot position (call buyer) or short spot position (put buyer)
• Time works against option buyer
• No performance bond requirement Option Seller
• Collects premium
• Obligation if assigned, resulting in a short position in the underlying spot currency pair (call seller) or long position (put seller)
• Time works in favor of option seller
When you buy an option you acquire the right, but not the obligation, to take a long or short position in a specific spot currency pair at a fixed price on the expiration date. For this right granted by the option contract you pay a sum of money or premium to the option seller. The option seller (or writer) keeps the premium whether the option is exercised or not. The seller must fulfill the obligation of the contract if the option is exercised by the buyer. How are options premiums (or prices) determined? While supply and demand ultimately determine the price of options, several factors have a significant impact on option premiums.

The Vocabulary of Options

Underlying Currency Pair
The underlying is the corresponding spot currency pair that is purchased or sold upon the exercise of the option. For example, an option on Euro/USD is the right to buy or sell EU/$ on the expiration of the option.

Premium
The premium is the price that the buyer of an option pays and the seller of an option receives for the rights conveyed by an option. Thus, ultimately the cost of an option is determined by supply and demand. Various factors affect options premiums, including strike price level in relation to the spot price level; time remaining to expiration; and market volatility – all of which will be discussed further.

Exercise
Exercise refers to the process whereby the option buyer asserts his right and goes long the underlying spot currency pair (in the case of exercising a call) or short the underlying spot currency pair (in the case of exercising a put). Only option buyers can exercise options. Sellers of options have the obligation to take the opposite and possibly adverse position to the buyers' and for this risk they receive the premium.

Exercise Price
Also known as the strike price, the exercise price is the price at which the option buyer may buy or sell the underlying spot position upon expiration. Exercising the option results in a spot position at the designated strike price. For example, by exercising a Euro/USD 1.24 call, the holder of the option would then be long a spot EU/$ position at 1.24.

Expiration Date
This is the day on which an option can be exercised into the underlying spot currency pair. After this point the option will cease to exist: the buyer cannot exercise and the seller has no obligation.

Offset
The buyer is under no obligation to exercise an option. As a matter of fact, many traders choose to offset their position prior to expiration. A trader will offset his position if he wishes to take profits before expiration or limit his losses on the downside. A buyer can offset his option by selling his option before expiration. An option seller can offset his position by buying back or "covering" his short position.

Time Remaining to Expiration
An option's value erodes as its expiration nears. An option with 60 days until expiration will have greater value than an option with 30 days until expiration. Because there is more time for the underlying spot currency pair to move, sellers will demand, and buyers will be willing to pay, a larger premium.

Option Premium Quotations
Option premiums are quoted in a similar manner to spot fx. Therefore, options are quoted in pips, which is the same as calculating the p & l for an underlying spot position.

Breakeven Points
As mentioned previously, options are versatile instruments that allow the trader to capitalize on a market opinion while limiting risk to a predetermined amount. The maximum amount the option buyer can lose is the premium that he originally paid, plus his brokerage commissions. But before initiating an options position he should first calculate his breakeven point. To calculate an options breakeven point the trader uses the strike price and the premium. Knowing breakeven points will help traders choose more effective strategies.

Time Value Decay
As discussed in the previous section, the value of an option beyond intrinsic value is called time value. It is the sum of money option traders are willing to pay given the likelihood of the option increasing in value. Time value erodes as each day passes, accelerating as expiration nears. This characteristic of options is referred to as time-decay and is the reason why options are sometimes considered "wasting assets." If time passes and the underlying futures contract does not move far enough by expiration, the option's time value will decay and the option trader may incur a loss. The graph below illustrates the principle of time decay and its acceleration as expiration draws near.

Performance Bond
An option buyer must only put up the amount of the premium, in full, at the time of the trade. However, because option selling involves more risk, an option seller or writer will be required to post performance bond.

In-the-Money
A call option is said to be in-the-money when the spot currency pair price exceeds the option's strike price. A put is in-the-money when the spot currency pair price is below the option's strike price.

At-the-money
An option is at-the-money when the spot currency pair price equals the option's strike price.

Out-of-the-money
When the spot currency pair price is below the strike price (for calls) and above the strike price (for puts) the option is said to be out-of-the-money. An option that has no intrinsic value, but only time value, is out-of-the money.


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