Call and Put Options
Traders can now sell or buy through online forex trading platforms. When buying an option, traders must pay a premium. If the market has moved in his/her favor, the buyer may exercise his right to his buying option and receive the option value from the option seller. When selling an option, traders receive a premium.Buying a call option:
The options contract gives the buyer the right to buy a predetermined amount of currency from the options contract seller at a set price (strike) and within a specific time – he will buy if it’s profitable. In this case, the buyer believes that the rate will go up and will want to buy it at lower price. For that right, the buyer will pay the premium. The following diagram shows the possible payoff of a call option buyer:
Example:
The current rate of the EUR/USD 1.3450. You believe that the rate will rise and thus want to benefit from a lower rate. You buy a call option on a lot ($100,000) of EUR/USD at the strike price of 1.3460 in 30 days. The premium is automatically calculated by your online trading platform. Let’s say you pay a premium of $500* for this option.
a) You were right, the price rises to 1.3520, and you exercise your right to buy at the strike price on the expiry. Your profit is equal to = $10 (value of one pip) x (market price-strike price, in pips) – premium = 10 x (520-460) – 500 = $100*
b) You were wrong and the rate goes down to 1.3400. The option expires worthless and you lose the premium. On the opposite side of the transaction (see “Selling a call option,”) the seller receives the premium.
Buying a put option:
This options contract gives the buyer the right to sell a predetermined amount of currency at a set price and within a specific time. The buyer believes that the rate will drop below the strike price before the expiration date so he’ll want to sell it at a higher and not lower rate. To obtain this right, the buyer pays the premium.
The following diagram shows the possible payoff of a put option buyer:
The possible loss is equal to the premium value.
Example:
The current rate of the EUR/USD 1.3450. You believe that the rate will go down and thus want to benefit from a higher rate to sell. You buy a put option on a lot ($100,000) EUR/USD at the strike price of 1.3445 in 30 days. Let’s assume your broke asks you for a $400 premium.
a) You were right, the price goes down to 1.3350, and you exercise your right to sell at the strike price. Your profit is equal to: (difference between strike and market price, in pips x $10) – premium = 95 x 10 – 400 = $550.
b) You were wrong and the price goes up to 1.3500. The option expires worthless and you lose the $400 premium and not more.
Selling a call option:
I believe that the asset will go down till the expiry date, therefore I’ll want to sell it to whoever believes that the currency will go up and in exchange for the option I’ll receive premium.
Selling a put option:
