Foreign Exchange Options Beat Leverage Everyday

The foreign exchange market is perhaps the world’s largest and most liquid market. Over $2 trillion each day moves through this market in a variety of currencies. The foreign exchange market is the market that never sleeps, as investors can trade currencies 24 hours a day. Investors are continually bombarded with advertisements informing them of the spectacular profits to be made trading foreign exchange. Everyone has read a story of the trader who claims to have multiplied their money tenfold in less than a year through foreign currency trading. However, in order to make these kinds of returns, one has to take spectacular risk, which is normally done through the use of leverage. Leverage is like purchasing stocks on margin, except that investors can obtain much more leverage for currencies than margin for stocks.


Investors, however, need to exercise caution when exercising leverage to make trades. Leverage means that investors are borrowing money from a foreign exchange brokerage to increase the amount of currency they may purchase in their accounts. While leverage can enable investors to multiple their returns, the use of leverage is extremely risky. Borrowing money to trade currencies means that even the smallest of moves magnifies the investment result for the trader. A one percent moves when a trader is trading at ten times leverage will wipe out ten percent of the trader’s account. If the trade moves against the investor, losses still must be paid, even if the money to trade was borrowed.


Investors need to be careful in order not to risk their entire capital in one trade because that is a surefire recipe for disaster. One way to minimize the amount of risk is through the use of foreign exchange options, which can be bought through TradeBNP. Many investors fear options, but that fear simply results a lack of knowledge of how options actually work.


Options come in two primary denominations, put options and call options. Call options entitle the investor the right, but not the obligation, to purchase a foreign currency at a certain price at a certain specific date. The price at which the investor is able to purchase the currency is called the strike price. For example, let’s hypothetically assume that the Euro is trading at $1.20. If an investor believes that the Euro will appreciate against the dollar, the investor can purchase a call option on the Euro. Let’s assume that the investor is very bullish. That investor can purchase an out-of-the-money call option that would entitle the investor the right to purchase the Euro at $1.21. Why would an investor want to own the right to buy the Euro at $1.21 when it is currently trading at $1.20? If the Euro rises to $1.25, the terms of the call option dictate that the investor can still purchase the Euro at $1.21, and the investor has made a sizable profit.


There are risks in purchasing foreign currency options. The right to buy the currency at the strike price does not exist forever. Instead, the right expires at a certain point in time. If the currency is trading below the strike price at the point where the option expires, it becomes worthless, and the investor has lost all of their investment. The benefit of the call option, however, is that it limits the potential loss that an investor can experience. All the investor can lose is the premium that it cost to purchase the option. The investor does not have to use leverage and their downside is capped.

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