Trading FX Options – Is it for me?
With access to almost unlimited liquidity, the FX market has to be the most exhilarating markets to trade in the world. There are almost weekly events that can cause massive movements in currencies that result in an abundance of trading opportunities. Finding these opportunities for the trained eye, is really not that hard. But once you’ve found an opportunity holding onto your capital and growing your account is not so much a battle of how well you are a trader, but how well you can manage yourself. The ability to interpret information and make the right decisions is something you have to learn to develop but there are plenty of resources out there to assist.
I’ve been trading on and off for the past 10 years or so and have had a variety of amazing experiences and absolute trading disasters. But I’ve learned to be a lot more disciplined over the years to improve my trading as I become more and more consistent. How i’ve managed to discover this consistency is through combining options trading with the FX market.
FX Options give you the right to buy or sell a certain currency pair at a certain point in time. They can work on margin or cash but are generally highly leveraged and considered a derivative type of trading instrument. They are generally traded through a CFD provider and whilst highly liquid, they don’t have the same regulations and rules as a plain vanilla style share or index option.
If you’ve ever traded Share or Index Options, they don’t offer the same type of trading products like Spreads or Butterfly’s or Iron Condors. Its a bit more basic in that you can buy or sell calls or puts. But the leverage is insane. For $1,000 you can control up to $100,000 of capital on the live FX market, but through an FX option.
You not only have the high liquidity of the FX market supporting you but you also have volatility in the premium price. This can vary significantly between brokers so its important you research this in depth before committing any serious money to trading. The other thing to note is that its a double edged sword in that if you are right with direction, you can make money very quickly within days, hours or even minutes. However, with FX options if you are a seller of premium your position can fall into loss making very very quickly if you are too close to being ITM.
An example of an FX Options Strategy that has worked for me, is that I sell a Put in which I receive premium with around 40 days until expiration. I usually take a medium term directional trade such as the bullishness in the USDJPY. I sell a put well away out of the money, at a minimum 400+ pips away. But I get into the trade when the market dips. The benefits of this are you receive the premium upfront and spend the rest of the trade awaiting for the option price to fall in value. As time goes on the time decay eats away at the option price, which is what you want as the less its worth the better for you being the seller.
Be careful of the amount of spread you lose when entering the trade, it is no where near as tight as the spot market and can put you in a loss making position from the time you enter the trade. But with a medium term outlook of say 40-60 days, you will have time to recover into profit if your direction is correct.
It is important to research and become engaged with the market. I generally checkout FXEmpire.com which gives great technical analysis, forecasting, fundamental research and whatever you want to know about FX, Commodities, Indexes etc.. Another great source of information is Investing.com, which is another great source of information about the markets, news and economic data.
Some great trades I’ve done recently were to sell put options in the USDJPY around 45 days out when the market was falling. Lets face it, currently in 2014 and early 2015 the Japanese Yen is extremely bullish and doesn’t look like its going to fall drastically anytime soon. It has some really good support at 115 and has the Japanese government working strategically to weaken the Yen as well as the US going from strength to strength, so a great pair to be trading at the moment.
So I basically as the market was on a bit of a sell off and went as low as 116, which was quite a bit of an overshoot, I was selling put options at around 200 pips below the market, know that the market would be finding support and due for a rally. Very soon after this trade was executed, the market bounced back into bullish territory and was back up around the 118 level. The position was already up 200 pips higher than I got in. On a $1,000 investment for a couple of weeks work i’ve doubled my money, not bad!!
The plan is not necessarily to hold onto this position until expiration, but until around 30 days until expiration, of which time decay can work significantly in your favor during this period. I would never hold the position until expiration unless it is staying a good 400 pips away from the market price.
Where you can really go wrong as i’ve mentioned, is being too close to the market price in which this can significantly affect the options price that you pay. Secondly, just picking the wrong medium term direction of the pair, as once you get into these FX options, you are initially losing on the spread until the market moves in your direction. This sometimes take 50+ pips before you’ve broken even to cover this spread. Depending on the broker, they don’t always allow you to set limit orders and to be honest this is how the brokers make their money.
The potential to make money with FX Options however is massive and gives any everyday trader plenty of opportunities and just look how many there are. But money management, trade size and protecting the risks are the main demons you need to overcome to be successful. You can easily make 25%, 50% or even double your account size in a matter of days using FX options. But be very wary you can losing it just as quickly if you don’t protect your positions, particularly using naked options as i’ve described a trade above.
I would love to hear your trading experiences with FX Options and whether you’ve ever traded with naked options.