Forex Options Types

In forex as in the stock market there are several types of options. In most categories, there are two forms of options: call and put options. In their regular and most simple configuration, these belong to the "vanilla” category. At Finotec, we have added for your convenience two types of options strategies in this category: the strangle and the straddle options strategies. These combine both forms of options (call & put) in different ways and can be assimilated to basic option strategies.

On the Finotec Trading Platform, you can also trade other forex options types such as "barrier” and "binary” (also known as "digital” options). They both belong to the wider category of "exotic options,” which are very developed in the foreign exchange market, and which refer either to variations on the payout characteristics of plain vanilla options or to options whose validation or invalidation is conditioned by additional factors (other than just the expiration time and the strike rate).

Vanilla Forex Options

Plain vanilla options refer to standard forex options types: they are defined by a standard strike price and expiration date and refer to the buying or selling of a standard call or put option. They give the buyer (holder) the right, but not the obligation, to buy or sell a set amount of currency at a certain rate and before a certain date. For this right, the holder of the options contract pays the premium (option price) to the seller (writer). According to evolution of the market and the profitability of the option, the holder of the option contract will decide to exercise or not his option. On the Finotec Trading Platform, traders may buy or sell call and put options. Note that put and call options are two separate contracts different from one another and not the other side of the same transaction.

Call option

A forex call option gives the buyer the right, but not the obligation, to buy a predetermined amount of currency from the options contract seller at a set rate (the "strike price”) and before a specific date (the expiration date). In the case of a regular call option, 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.

Put option

A forex put option gives the buyer the right, but not the obligation to sell a predetermined amount of currency at a set price (strike price) and within a specific time (before or on the expiration date). 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. In return for this right, the buyer pays the premium to the writer.

Option Strategies

Traders make their own option strategies by combining different options. With Finotec, two option strategies are directly available from our platform: the strangle option strategy, and the straddle option strategy. Both these strategies are a combination of two vanilla options. This means that you don’t have to open two options separately to implement either of those strategies, you just click “strangle” or “straddle” and fill in the requested inputs and both options will open automatically at the same time.

Strangle Strategy

This options strategy consists in buying or selling a call and a put option at different strike prices. A trader will get a long strangle option (buy) in expectation of a sharp swing of the exchange rate in either direction. The long strangle strategy has unlimited profit potential if the exchange rate moves enough in either direction. The value of a strangle option increases along with the volatility of the underlying currency pair.

Straddle Strategy

This is another type of option strategy and it consists in buying (long straddle) or selling (short straddle) both a call and a put option at the same strike price and for the same expiration date. A trader will get a long straddle option (buy) when he/she expects highly volatile market conditions. The value of a straddle option (premium) increases along with the volatility and the maturity of the underlying currency pair.

Barrier Option

Barrier options belong to the category of exotic options – extremely popular among forex option traders – meaning that they possess a component other than the expiry date and the strike price. Regarding barrier options, the additional component is the trigger – or the barrier – which if reached either brings the option into being (knock in option) or cancels it (knock out option). You thus choose a strike price as well as a trigger. Since there is a chance that these options may never come into effect or may be canceled, they are generally cheaper that their vanilla counterpart. Exotic options also include binary options which are based on a hypothetical scenario where you decide how much profit you want to make if the rate reaches a certain level.

Knock in

A knock-in option becomes a regular option (it is "knocked in”) if and when the trigger price is met before the expiration date. This means that if the rate is never reached, the contract is canceled and the buyer loses the premium. If the barrier rate is met, then the option starts running like a regular put or call option. Knock-in options are less expensive than regular options since they have an additional conditional component that cheapens the price of the premium. The further the barrier to the spot rate, the cheaper the premium, since there is a lesser chance that the option will be knocked in before the expiration date.

Knock out

The knock out option will automatically cease to exist and expire worthless (it will be "knocked out”) if and when the trigger price is reached before the expiration date. If the rate never hits the barrier, the knock out option runs the same way as a regular option. For a call knock-out option, the trigger is set below the spot rate, and above for a put (out-of-the-money). The higher the implied volatility, the greater the chance the barrier being triggered and the option being knocked out. Knock-out options are cheaper than regular put or call option (vanilla) since they may be knocked out before expiry. The premium gets cheaper as the barrier gets closer to the spot rate since the option has a greater chance of being knocked out.

Reverse knock in

The difference between a knock in option and a reverse knock in option lies in the localization of the trigger barrier. Whereas the trigger is out-of-the money for a knock in, it is in-the-money for a RKI.

Reverse knock out

The difference between a knock out option and a reverse knock out option lies in the localization of the trigger barrier. Whereas with a regular knock out, the trigger is set out-of-the-money (meaning below the spot rate for a call and above for a put), with a RKO, the trigger is set in-the-money (above the spot rate for a call and below for a put).

Binary options

Binary options (also known as "rebate” options), are vanilla put and call options conditioned by something else other than just the price and the expiration date. They refer to conditional scenarios that if come true, either validate or invalidate the option. The trader fixes the amount of the desired payout he will get if his conditional scenario proves to be right. The price of the option or premium represents a percentage of that payout.

One Touch

When buying a one-touch option, traders set that if the currency trades at a specified rate (trigger), then he/she will receive a profit whose amount he has decided upon. He thus knows in advance the extent of his potential profit (payout) and loss (the premium).

No Touch

When buying this type of option, the trader sets that he/she will make profit (whose amount he/she sets) if and only if a currency rate does not reach the specified trigger before a specified time. The further away the trigger from the spot rate, the lesser payout potential, since there is greater probability that the currency will not touch the strike rate.

Double One Touch

With this type of option, traders choose two triggers and set the profit they will make if either one is hit. Usually, double-one-touch options are used when traders expect highly volatile market conditions but don’t know what direction the market will take. In this sense, double one touch options are similar to long straddle or strangle options.

Double No Touch

Double no touch options are the opposite of the double one-touch options. Traders buy them when they expect a range-bound market with a relatively low volatility. In general, this type of option is profitable during the periods of consolidation that usually follow significant market moves.

Traders often combine various option types to build their option trading strategies. By associating different option types, some traders manage to minimize the risk they are taking. Some even claim to have found infallible methods. Others see it as a simple hedging instrument and use it to secure their funds.