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Beginner Level : Chapter 1

Welcome to OptionsEDU™, the roadmap to foreign exchange trading.

From the most basic question, “WHAT IS AN FX OPTION?” to the complexity of “THE GREEKS”, we are your personal roadmap to foreign exchange trading.

We’ve broken down the main lessons into three levels: Beginner, Intermediate, and Advanced Levels. You will also learn from the extensive segments on Options Strategies we provided, including Leverage and Hedging Strategies and Options Strategies for Spot Traders. We also included two interactive applications, an Option Value Simulator and an Option Calculator, plus a comprehensive Glossary to ensure all your terminology questions are answered.

This course is designed for your educational experience. At the end of each level, we recap important topics with Q&A Level Reviews to help you assess your progress.

Agenda

  • It All Begins with a Handshake
  • Call & Put Options
  • Size Matters – Contract Size
  • Currency Pairs
  • Long and Short Positions

It All Begins with a Handshake

What are FX Options? – FX Options are financial contracts.

While stock options are mostly traded on exchanges, in the ordinary course of business, FX options are contracts that traders and dealers enter into with one another when they buy and sell to each other.

FX options are financial contracts between traders and dealers

A trader can either buy an FX option from a dealer or sell an FX option to a dealer.

Obligations under a contract are reversed depending on whether the trader is the buyer or the seller.

So what exactly are the rights and obligations involved in this contract? Well, the buyer is the Holder and the seller is the Writer.

Key Terms: OPTIONS

Call & Put Options

The two fundamental types of FX options are CALLS and PUTS.

A call option gives the holder the right (but not the obligation) to buy from the writer so many units of a currency at a specified price called the strike price.

A put option gives the holder the right (but not the obligation) to sell to the writer so many units of a currency at a specified price called the strike price.

  • What is the STRIKE PRICE?
    Strike Price, also known as the “exercise price,” is the stated price at which the buyer of a call has the right to buy a specific currency, or the stated price at which the buyer of a put has the right to sell a specific currency

Key Terms: CALLS | PUTS

Size Matters

Contract size

An option’s size specifies the number of units of currency that one option contract leverages.

Contract sizes are different for options written on different currency pairs.

Currency Pairs

Like FX currency contracts, FX option contracts are quoted in BASE/QUOTE currency pairs.

The base currency is also often called the underlying currency.

If you always buy and sell foreign currencies with your domestic currency and buy and sell foreign-currency options with your domestic currency, you can think of the quoting convention as Foreign/Domestic.

For example, a SPOT price for EUR/USD of 1.5 means that 1 Euro costs $1.5. A EUR/USD call option with a strike price of 1.6 and an ASK price of .02 would cost the buyer $.02 and give him or her the right to purchase Euros at a price of $1.6 per Euro.

With USD as the base currency, a spot price of USD/JPY of 87 means that $1 costs 87 Japanese Yen.

If you are familiar with buying and selling stock options, for FX options, the base, foreign or underlying currency is analogous to the stock.

The quote or domestic currency is analogous to cash.

Common currencies in which a dealer might make a market in currencies and options include these currency pairs and contract sizes:

Base/Quote Currencies Contract size
AUD/USD Australian vs. US 100,000
CAD/USD Canadian vs. US 100,000
CHF/USD Swiss vs. US 100,000
EUR/USD Euro vs US 100,000
GPB/USD Pound vs US 100,000
JPY/USD Yen vs US 100,000
NZD/USD New Zealand vs US 100,000
AUD/JPY Australian vs Yen 100,000
CAD/JPY Canadian vs Yen 100,000
CHF/JPY Swiss vs Yen 100,000
EUR/JPY Euro vs Yen 100,000
GPB/JPY Pound vs Yen 100,000
USD/JPY US vs Yen 100,000
AUD/CAD Australian vs Canada 100,000
EUR/CAD Euro vs Canada 100,000
USD/CAD US vs Canada 100,000
EUR/CHF Euro vs Swiss 100,000
GPB/CHF Pound vs Swiss 100,000
USD/CHF US vs Swiss 100,000
EUR/AUD Euro vs Australian 100,000
EUR/GBP Euro vs Pound 100,000
AUD/NZD Australian vs New Zealand 100,000

To incorporate the Base/Quote price-quoting convention into our definitions, a call option gives the holder the right to buy so many units of the base currency from the writer at a strike price expressed in the quote currency.

A put option gives the holder the right to sell to the writer so many units of the base currency at a strike price expressed in the quote currency.

Key Terms: ASK PRICE | SPOT PRICE

Long and Short Positions

When you buy options, you create a long position.

When you sell options, you create a short position.

(Selling options is also spoken of as writing options or granting options.)

  • If you think a currency’s price will rise, buy calls or sell puts. If you think a currency’s price will fall, buy puts or sell calls.
  • If you believe the price of a base currency is likely to rise relative to a quote currency, then, as a simple trading strategy, you may want to buy calls or sell puts. That is, you may want to go long calls or short puts.
  • If you believe the price of a base currency is likely to fall relative to a quote currency, then you may want to buy— go long— puts or sell— go short— calls.
  • If you buy an FX call or a put, you pay for the option in the quote currency. If you sell an FX call or put, you are paid for it in the quote currency.

Key Terms: LONG POSITION | SHORT POSITION

Summary

  • It All Begins with a Handshake
  • Call & Put Options
  • Size Matters – Contract Size
  • Currency Pairs
  • Long and Short Positions

Next: Chapter Two

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