Tips on Trading Forex Options

This is a very interesting and comprehensive article on trading Forex Options written by Paul Stafford who frequently contributes to the comment sections of my blog.

He is a guy who loves complex analysis! He started out as an engineer at NASA, designing image processing hardware used in infrared astronomy. Later, he designed the tracking telescope and hardware used in the IRIS program (InfraRed Imaging of Shuttle) to generate images of the Space Shuttle re-entering the atmosphere. Paul then continued his engineering career at Hewlett Packard, where he specialized in calibration algorithms for RF and microwave signal analysis and generation. With several patents under his belt, he moved to the marketing and finance side of HP and became fascinated by the economics of the business.

Here’s a snippet from his Options Article (Download Entire Report). Let me know if you enjoy it!

Higher Return/Risk from Forex using Options

By Paul Stafford

Introduction

In this paper we review common methods of trading the Forex markets, and examine a new method, using Forex options, which offers several significant advantages over traditional methods. In this paper, I assume a basic knowledge of trading the Forex spot market.

Trading the Forex market in any manner has many advantages over other markets (such as equities). It is highly liquid, very large, almost impossible to manipulate, its volume driven mainly by commercial trade need (not speculation), and the relevant data is transparent and easily available (except trade volume). However, there are some real pitfalls. If we’re wrong directionally and the market finds us, losses can be severe, even at lower leverages. A modicum of volatility is good for trading, as movement is what sustains a market. However, during the last year volatilities have been enormous. With a 24/5 market, you can’t always be there to monitor positions. The use of stops can prevent a blown account, but they also lock in losses, sometimes needlessly.

As we will see, trading Forex with options preserves much of the advantages of trading Forex, and eliminates some of the downsides:

(Download Entire Report). *The views and opinions are that of Paul Stafford and not Kathy Lien.

36 Comments

  1. Paul,

    Excellent article on FX options!

    An other way to model the PURCHASE of an option is to consider it a market position with a stop loss. The premium you pay for the Option may be be used to set a stop price and the number of times you are willing to buy back that position if you are stopped out, including the cost of being stopped out.

    As you well know 90% of Options expire worthless

    Why do satellite image processing guys gravitate to Forex?

    Reply
  2. thanks for the comments, Fred!

    modeling an option with underlying and stop isn’t an exact corollary, because I can wait out multiple adverse and large moves in excess of multiple stop/premiums, without the need to buy back in. my main worry is the time element, of course, when I’m long the option. I”m usually 6-10 months out.

    as to 90% of options expiring worthless, you must remember to think of all the smart folks who SOLD those options for the premium, and are ecstatic their plan came together and the options expired worthless!

    some of the best spreads are the combinations of long and short options to create a particular strategy (eg call and put backspreads). in all of those cases, the optimum outcome is for the short position to expire worthless…

    old engineers gotta go somewhere, I guess. I went to western Montana, but only as far as DSL stretches :)

    Reply
  3. The original comment was meant for an Option At the Money(ATM) and you are right with Vols at 19% for uSDJPY it is better to SELL the option to make money but there goes the SLEEP you cherish!

    I started on Landsat but North of the Border.

    Thank goodness I am on cable at 16Mbit. My DSL was barely 2 Mbits while in Europe I was getting 8/16 Mbit service.

    Reply
  4. Hi Paul,

    Very good article.

    I’m interested in calculation of volatility, I mean GARCH system. This article really good for my study.

    Thanks again.

    Reply
  5. Hi Paul,

    Wow! You really a Forex options trading expert. The tips you share with us were useful to all of us especially for those who want to make a living trading forex options.
    Please continue the good work. Thanks again.

    Reply
  6. BTW, I just got an email from Saxo bank indicating their option spreads have narrowed substantially.

    here is the text

    “We have narrowed options spreads considerably in nearly all of our currency pairs!

    We continue to believe that our option prices are around 20% inside the broader market, so again please make sure you fully understand and appreciate access to such quality prices. Given that it is only natural that price spreads in our major currency pairs will be tighter than those in our less active instruments, never hesitate to give us specific feedback if ever a client/partner might demonstrate that our prices are not the best available on any specific option quote so that we have a chance to improve together.

    As usual, our friends and colleagues in Institutional Center will be helping to set Options spreads as per the attached:”

    They had a an attached file with the new spreads, and most were 5-10 pips lower

    Reply
  7. Hi guys,

    thanks for the kudos. We must remember this is Kathy’s site, not mine, so more full-blown articles are probably not in the cards. not that I don’t have ideas :)

    I would like to point out that I write a weekly newsletter (16 pg) with all the sorts of data I’ve been posting and more. go to http://www.4xtradertools.com and you’ll find a sample.

    Paul

    Reply
  8. Thanks for your artice Paul. I trade options on thinkorswim but havent traded forex options. Im interested in trading forex options using long delta/gamma strageies given that forex can move alot. given that 1 question I have is the disadvantage of options only trading during the NY market hours whilst forex is traded 24 hours.

    There must be a risk attached to this?

    Reply
  9. Optiontraderman,

    Sorry I didnt see your response earlier.

    SaxoBank makes a market in FX options, with reasonable spreads, and it’s open 24/5, just as the Fx market is. It’s where I trade for the reason you mentioned.

    Reply
  10. you bet.
    all of you may already be aware of this, but I just read this:

    Being able to hedge a trade in the same account is soon to go away if you use an NFA broker (eg FX solutions)

    NFA Notice I-09-10

    Offsetting Transactions

    New Compliance Rule 2-43(b) requires an FDM to offset positions in a customer account on a first-in, first-out basis, thereby prohibiting a trading practice commonly referred to as “hedging.” A customer may, however, direct the FDM to offset same-size transactions even if there are older transactions of a different size. Rule 2-43(b) is effective for any positions established after May 15, 2009. Offsetting positions that were established prior to the effective date do not have to be liquidated, but once either position is closed out after May 15, it may not be reestablished as a hedge.

    so beware. I can recommend two ways around this.
    1) use a non NFA but reputable broker like Saxo (regulated by The Danish FSA)
    2) trade FX using options like I do. you can hedge all day long and no one can stop you…

    Reply
  11. In a world where individual traders get more and more sophisticated in their goal to trade like hedge funds, NFA wants to make sure they do not. Quite outrageous for a supposedly free nation to set a rule that refers TO THE ORDER IN WHICH PEOPLE TRADE. Glad I’m not american!

    Reply
  12. This is good to know besides being useful. I have been going through a very good online trading company and they been guiding me for years. They have a functional range of technical analysis tools and charting programs as part of their trading platforms and with the amenity of customized solutions, the client has the opportunity to optimize trading methods.

    Reply
  13. Thanks for sharing these thoughts. This has been very helpful to me. Looking forward to read more about forex trading.

    Reply
  14. There are many types of options available in the Day Trading market to choose from. These different types give you the much needed flexibility in your trading. One of the many types is the forex option.

    Reply
  15. You can maximize your profits by fully understanding how to analyze binary options. It is easy enough to do – no need to be an expert or seasoned veteran of the finance industry. Novice traders can quickly master binary options.

    Reply
  16. Speculate whether or not you think the price of the underlying assets of a specific binary options will move up or down. Then purchase the appropriate option – a Call option for an up swing or a Put option for a down swing

    Reply
  17. I wish more people would write blogs like this that are actually fun to read. With all the fluff floating around on the net, it is rare to read a blog like yours instead. while searching on internet i came across one such site that offers earning money by online forex trade http://onlineforexfuturestrading.com/

    Reply

Leave a Comment.