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What are forex options?

You can guarantee the exchange rate doesn't get worse before you buy currency — for a fee.

Updated

What are foreign exchange options?

A foreign exchange option — also known as a forex option, FX option or currency option — is a type of foreign exchange derivative that gives you the option to buy or sell currency at a specific price.

Options are intended to give you more flexible opportunities in the future and protect you from unfavorable fluctuations in the exchange rate of a currency.

How foreign exchange options work

Just like its name implies, a foreign exchange option gives you the choice to exercise a trade at a specified exchange rate, known as a strike price, up until an agreed-on date in the future, known as the expiration date or expiry date.

When you buy the right to an option, you pay a fee to the seller of that option, called a premium. If you acquire the right to buy a currency, you have a call option. If you acquire the right to sell a currency, you have a put option.

Foreign exchange options: An example

Let’s say you need to pay your overseas supplier 5.5 million yen (a little under $50,000) in five months. The dollar-to-yen exchange rate is great right now, but you don’t want to exchange your money and sit around with a bunch of yen for months.

What you can do is put a call option on the yen — one that gives you the right to buy the currency in five months at the current exchange rate. If the dollar weakens against the yen (it other words, if it buys you fewer yen), you can exercise your option. If the dollar strengthens against the yen, even better — you can simply lose the premium you paid for the option and buy yen at a superior price.

Why is a foreign exchange option useful?

You can use a foreign exchange option to protect yourself if exchange rates move against you.

Among the advantages of an option is its flexibility — it doesn’t force you to buy or sell currency. If exchange rates are unfavorable, you can choose not to exercise your option and simply lose the premium you paid to the seller of the option.

European vs. American options

European options can only be sold on the expiration date, while American options can be bought/sold any time before that date.

For example, if you have a European call option on euros that matures on August 3, you’ll need to either buy euros or lose the option on August 3 — not before or after.

If you have an American call option, you can buy euros any time before August 3.

What is a binary option?

Binary options are a much riskier type of option. They work as an all-or-nothing gamble that’s worth either $0 or $100 on the expiration date.

For example, let’s say you buy a binary option for $50 that says the euro/US dollar ratio will be more than $1.10/$1.00 on October 1, 2019 at midnight. When that date rolls around, if the ratio is higher than $1.10/$1.00, your option expires and is worth $100. But if the euro is worth less, your option expires and is worth $0.

How to trade forex options

If you want to trade foreign exchange options, you’ll need to find a reputable broker. While it is possible to trade options directly with a buyer or seller, known as OTC options, it’s generally much riskier than going through a reputable exchange.

Compare forex trading platforms

Name Product Available asset types Minimum deposit to open Maximum Leverage Annual fee
IG
IG
Stocks,Forex,Cryptocurrency
$300
50:1
0%
IG offers tight spreads and lets you access over 80 currency pairs with leverage as high as 1:50, but the platform is far from risk-free and losses can exceed deposits.
Forex.com
Stocks,Forex
$50
Up to 50:1
0%
Largest forex broker in the United States with assets of $1.449 billion.
Interactive Brokers
Stocks,Bonds,Options,Mutual funds,Index funds,ETFs,Futures,Cash
$0
Varies
0%
IBKR Lite offers $0 commissions, and IBKR Pro offers advanced tools for professional traders.
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Compare up to 4 providers

Are there any drawbacks?

There’s always the possibility that you won’t be able to favorably exercise an option, in which case you’ll be holding a worthless option. If that happens, you won’t get back the premium you paid.

And if you purchased a binary option, you could lose all of the money you invested on the option.

Is there anything else I should know?

Typically, time is working against you when you buy an option. That’s because the less time you have left in an option, the less of a chance you’ll see a favorable window to exercise it.

An introduction to forex futures

Bottom line

Forex options are one way you can make money trading currencies. But no trades are risk-free trades, and you won’t get your premium back if you don’t use the option.

If options trading isn’t what you’re looking for, compare other ways to trade forex.

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