Forex and Currency Options

Fundamentals of Futures and Options Currency Exchange Markets

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Futures Trading Market

The currency futures, a type of forward outright deals, are derived from the spot price. As a result they are classified as a derivative instrument.

The date at which the deal expires as well as the size of the trade amount are fixed. Additionally, in contrast to the regular forward outright deals, foreign currency futures mature specifically on the third Wednesday of March, June, September and December.

The forex futures trading is popular because of the following factors:

  • The futures market is open to all, including individual market participants.
  • It has a centralized structure and in the same time provides the same efficiency as cash markets.
  • No credit risk – the Chicago Mercantile Exchange Clearinghouse represents the common buyer of all sellers. The opposite is also true.
  • There are some technical analysis tools that one can find only on the futures market such as gaps, volume and open interest.
  • Currency futures trading volume is one of the major factors that attracts many players to the market.

Eventually, futures contracts are transformed into spot contracts since the first represent a forward outright contract that includes forward prices, which change relatively slowly and forward spreads will be eliminated with time.

Currency Options Market

A currency option includes two parties – a buyer and a seller. Under the conditions of the option the buyer has the right, but is not obliged, to trade a fixed amount of a currency. The trade is done at a pre-specified price and time. On the other hand, the seller (also known as the writer) is obliged to execute the trade by providing the specified amount of the currency at the specified price.

The price of an option is influenced by many more factors than the price of other foreign currency tools that are available to forex market participants. All factors are compared and analyzed on the basis of the currency price. It is the price of the target currency that defines the need of an option. It also determines the profitability of the corresponding option.

The simplicity and difficulty of applying options is addressed by traders with mixed feelings. Some regard them as easy to implement, whereas others misconceive their usage. Some view options as a cheap instrument, whereas others regard it as an additional security.

Additionally, the capabilities of options are generally misunderstood. The option on a currency futures rise the right, which is however not an obligation, to become the physical owner of the underlying currency on the side of the buyer. Also, though an initiation margin is not required when buying currency options, the depositing of a margin is required for the buyer to place when s/he becomes the physical owner of a currency future through an option.

Nevertheless, currency options are gaining more and more popularity, which is shown by the increase in the size of the segment that options occupy on the foreign exchange market.

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