Forex options (currency options) give the possibility to limit your risk in trading currencies. In this section of ForexBeginning we are going to delve into the topic of options, how to use them in the forex market and what option strategies exist out there.
What's an option?
Options are financial instruments which give you the right (but do not obligate you) to buy or sell a certain asset (in this case, a currency pair) at a predetermined price (called a 'strike price') before a certain date (called an 'expiry date'). As the value of an option to a large extent depends on or is derived from the rate of the currency pair, it falls in the group of financial instruments called 'derivatives'.
The strike price is the price at which the option can be exercised. After the expiry date, the option ceases to exist.
There are European-type options and American-type options. If you are holding American-type options you can exercise your right to buy or sell the underlying asset (the currency pair) throughout the lifetime of the option, while an European-type option can only be exercised on the date of expiration.
Options can also be Call or Put. Call options give you the right to buy a currency pair at the strike price, while Put options give you the right to sell a currency pair at the strike price
What's so good about forex options?
Well, when you buy an option you will know your maximum possible loss, which is the cost of the option (the so-called 'premium'). Options make it possible for you to have unlimited gains (obviously if the market moves in your direction) for the lifetime of the option.