For many investors, forex options trading present a great way to increase profit as well as minimize risk to their portfolio. Most market participants involved in hedging (the act of minimizing risk) are corporations which are engaged in import and export and would like to secure future exchange rates. On the other hand, speculators (investors seeking to increase profit) use forex options to profit in both trending and ranging markets.
Forex traders can use two types of options: the single payment option trading (SPOT) and call/put option. The call/put option works a lot like stock option and is more common between the two. On the other hand, SPOT options allow greater flexibility to traders because there are several ways to earn income this way. At present, there are several kinds of SPOT options – standard, the no touch (trader gets the payout if strike price is not reached), one touch (touches one of the set strike prices), double one touch, double no touch and the digital spot (market prices are above or below the strike price).
For this article, we will discuss the two trading strategies which can be used for the traditional call/put options (more commonly known as vanilla options) – the strangle and the straddle strategies.
The Straddle Strategy
In a straddle strategy, often referred to as the long straddle, the investor has to purchase the same number of at-the-money (ATM) call and put options with the same strike price and the same expiration time. This trading strategy is most useful in highly volatile markets wherein a major movement is likely.
While a straddle has many advantages, it also has its own disadvantages. For one, it is more expensive compared to simply buying puts or calls since it provides insurance to investments. Its maximum risk can be calculated by adding the cost of purchasing the two options contracts. If the currency exchange rates do not move and volatility is next to nothing, then the investor will lose. The investor can profit if the market moves on upward or downward.
When it comes to the straddle, timing is important. The investor needs to consider all factors, including technical analysis and fundamental analysis results, news releases and many others. Expert traders suggest long term investing to give the market sufficient time to move.
The Strangle Strategy
Of the two strategies mentioned on this article, the strangle strategy is considered as more conservative. Like the straddle, the strangle strategy also takes advantage of highly volatile market conditions. Another similarity is that it requires the purchase of the same number of put and call options. Unlike a straddle, however, the strangle strategy has different strike prices but the options will expire at the same time. It is also cheaper than a straddle because the put and call options are out-of-the-money (OTM).
The strategy used when the investor is expecting a sharp swing in prices but is uncertain with the direction it will take. To profit from this strategy, the market must move in any direction, and the movement must exceed the cost of purchasing the other option.