Forex Stock Exchange Forum
Would you like to react to this message? Create an account in a few clicks or log in to continue.
advertisement

Go down
x-man
x-man
Number of messages : 22
Points : 2118
Date of Entry : 2015-07-30
Year : 55

attention Types of Vanilla Options

Thu Jul 30, 2015 7:46 pm
Profit and loss scenarios

There are four types of actions when trading options, let’s take a look at them one by one:

Buy Call

Buying a Call gives the holder the right but not the obligation to BUY a currency pair at a specific date and strike price in the future. To do so the holder has to pay a premium up front to the option seller and will profit as the underlying price moves higher. Let’s look at the example below:
[You must be registered and logged in to see this image.]
The holder buys the option to buy the euro against the US dollar in three months’ time at a strike price of 1.3900 which has a premium of 10 dollars. As long as the price of EURUSD is below 1.3910 at expiry, the holder has no incentive to exercise the option. On the other hand, if the price rises by expiry, the holder is in profit as his position closes at a higher premium value.

The above graph shows the profit and loss at expiry for various spot prices. In this example, if the option expires at 1.3940, the trader would be in profit of 30 dollars. Now consider that even though the holder’s profit is unlimited, he is only risking the 10 dollars that he paid as a premium. This small risk with unlimited profit potential is one of the key benefits of options as a trading instrument.

A common question asked by first time option traders is: “What is the difference between the option premium and the stop loss used in the spot market?” When the spot market touches your stop loss, your position will be closed at a loss, while with options you have the ‘time’ dimension. You start by paying a premium and you have as much time as you specify for your position to come into profit regardless of how much the spot exchange rate moves against you.

A unique benefit of our options platform is that you don’t have to wait until expiry; you can close out your option at any time before and cash out. Keep in mind, when trading options you are trading the option premium and its fluctuation.

Sell Call

The seller becomes the ‘writer’ of a Call option and would be required to honour the terms of the option contract. He receives a premium up front. Let’s look at the example below:
[You must be registered and logged in to see this image.]

The seller sells the option to buy the euro against the US dollar in three months’ time at a premium of 20 dollars and strike price of 1.39. As long as the exchange rate of EURUSD at expiry is below 1.3920 the seller will keep the premium. On the other hand, if the price rises above 1.3920 the seller will start making losses since the spot price is higher than the strike price and the option seller would be required to honour the terms of the option contract. The seller’s profit is limited to the premium received of 20 dollars but the downside risk is unlimited as the market moves against the seller of the option.

Buy Put

Buying a Put involves paying a premium to buy the right to sell. The holder of a Put option will have unlimited upside once the spot price moves below the breakeven point.
[You must be registered and logged in to see this image.]

For example, the holder buys a Put option that gives him the right to sell the euro (EUR) against the US
dollar (USD) in the future at the strike price of 1.3890. Consider now that if the exchange rate at expiry is above 1.3880 he would prefer to sell in the market, and not exercise his option. In this case he only loses the 10 dollars paid as premium.

On the other hand if the price moves below 1.388, the holder can buy, for example, at 1.386 and still sell at 1.389 making a profit of 20 dollars, when accounting for the premium of 10 dollars he initially paid.With the easy-forex options platform you do not need to buy the spot. Instead the net cash is incorporated directly into your account balance at expiry.

Sell Put

The seller becomes the writer of a Put option and would be required to honour the terms of the option contract. The seller has to receive a premium up front. Let’s look at the example below:
[You must be registered and logged in to see this image.]

The seller sells the option to sell the euro against the US dollar in three months’ time at a premium of 20 dollars at a strike price of 1.389. As long as the exchange rate of EURUSD at expiry is higher than 1.3870 the seller will profit from the premium received. On the other hand, if the price moves below 1.3870 the seller will make a loss since the spot price is lower than the strike price and the option seller is obliged to sell the option. The seller’s profit is limited to the premium of 20 dollars but the downside risk is unlimited as the market moves below the breakeven point.

[You must be registered and logged in to see this link.]
Back to top
Permissions in this forum:
You cannot reply to topics in this forum