Currency trading is a huge market around the world due to globalization. As the trading in this market has increased it has caused the interest in currency option trading to grow as well. Options on currencies give the holder the right to buy(call) the currency at a set price called the strike price. The option has a set expiration date. If the currency price moves higher before expiration the option can be exercised. The currency is purchased to be resold in the market at a higher price. Put options are purchased if the currency price is expected to fall. If it does, the holder can purchase the currency in the market and put(sell) it at the higher strike price.
The traditional option is one type of contract available to traders. In situation the trader selects a strike price and the expiration date for the contract. They then receive the amount of the premium(cost)from the broker. If it is acceptable the trader selects the number of calls or puts to purchase and places the order. An example of a trade would be if the trader believes that the dollar will advance against the Japanese yen. He/She would buy a call on the USD/JPY. If the dollar does advance against the yen the option is exercised, and the dollar is purchased at the strike price and immediately sold at a profit in the market. This strategy exposes the trader to far less risk.
The SPOT contract is another type used in currency option trading. It is a “single payment option trade.” This means that if for example you feel that the euro will advance against the dollar and you buy calls on it, if you are right you do not need to actually purchase the currency and sell in the market to make a profit. The profit from the option is automatically deposited in your trading account. Brokers charge a higher premium for trading this type of contract, however for speculators is the easiest way to trade.
Premiums are the amount the broker charges for the option. If the currency is highly volatile the broker will set a higher premium. If the strike price is set close to the market price of the currency the premium will be raised. It will also be higher the longer the time span until expiration.
One reason people get involved in currency option trading is simply to speculate on the price movements of the currency. These people are solely profit driven. This is the largest part of the market.
Another use of currency option trading is for the purpose of hedging a portfolio. If a person is long the actual currency they may purchase puts in order to minimize the risk of price fluctuations while the hold the currency. People who do business international may use this strategy as a protective measure.
A riskier strategy of trading currency options is selling options short with the intention of covering them when the price moves in the correct direction. Since loses are not limited in this style of trading. brokers typically require large cash deposits to secure these trades.
To summarize, currency option trading can be as challenging as trading actual currencies with a few exceptions. Your loses are limited to the premium you pay to own the rights of the option. Profits can be huge as a percentage of investment if you trade correctly.