Why buy Fx options

I am a speculator of currency futures options having 34+ years experience in trading - that too in just one Currency Pair Eur/Usd (earlier Dem/Usd).

Buying (long) Call or Put options outright and predicting Breakout in advance is my preferred way of tradig.

The risk is defined in advance.

No margin calls will be made by the broker.

No money management is required.

No lots/positions management is needed.

The risk to reward can vary from a ratio of 1 to 4. Take Profit and Stop Loss may or may not be used.

Outcome duration is from 5 days to 20 days maximum. Otherwise, the Time decay factor will hurt the trades.

Currency Futures options instrument is regulated by Chicago Mercantile Exchange (CME). So there is no counter-party risk.

If compared with OTC spot currency or equity options trading, it is relatively less risky and won't affect my psychology.

I possess a temperament to accept a defined risk of loss which does not affect my lifestyle or interfere with my financial situation.

Not at all complicated to understand. Simple to analyze and execute. No chart watching or technical analysis is required. "Buy Low Sell High" concept. Don't get confused by the terminology of options assignment and exercise. You can buy and sell at any time just like spot currency.

A trader gets a lot of breathing space for the prediction to be wrong several times without the trade being liquidated - unlike a stop loss resulting in an irrecoverable loss, sometimes in a matter of seconds. It is therefore important to do the trades when you feel the downside is limited and a low-risk entry will be made. Timing is the key factor.

Only four symbols are liquid: Eur, JPY, Gbp, and Aud. I will go for the most liquid of them, that is EurUsd.

Minimum investment: Assuming a trader buys a Deep-in-the-Money EURUSD option by paying a premium of 200 points (each point costs $12.50 for a standard contrac value of $125,000) a capital of US$2,500 per contract will be required. In addition, the trader has to satisfy the minimum deposit requirement of a broker.

If you want to sell options, your broker has to extend you margin facility and normally, you should not attempt to sell the options unless you keep sufficient buffer cash in the account. Ideally, a US$25,000 investment will be required.

We can't expect more than 15 breakout opportunities in ONE YEAR out of which I target 8 probable chances for profit and likely to succeed in six of them.

The challenge is to guess ahead of time which currencies will start trending or stop trending and it does require staying on top of anticipated news and economic events. Having been a financial journalist does help me here.

Most of the bought options - from 75% to 90% expire without value. Credible evidence is not available but it is said most of them are bought and sold by speculators for a different objective. Mostly for hedging their assets and protecting their profits earned rather than speculating and so they keep the insurance intact until the last moment.

Time-decay hurts buyers of options

The value of an option is not just determined by the value of its underlying asset.

Simply put: you can lose money with options even if you make the right call about the underlying security but ignore time-decay.

Novice options traders often think that all they have to do is make the right prediction about an underlying currency pair and they can make a fortune by trading options. That’s not necessarily the case.

Option prices are affected by other factors as well. One of those factors is time.

All other things being equal, the price of an options contract will decrease every day it gets closer to expiration.

In other words, if the price of the underlying currency pair stays flat and implied volatility doesn’t change, you can expect the contract to drop in value every day. That’s because it’s easier to predict the outcome of the contract as it gets closer to expiration.

Market makers adjust the value of options contracts downwards as they get closer to expiration because the outcome is a little more certain every day.

Keep in mind: options prices will decrease more as they approach the expiration date. In other words, time-decay for an options contract that expires tomorrow is greater than the time-decay for an options contract that expires in three months.

Time-decay, by the way, is measured in theta. That’s one of “the Greeks” that options traders use to evaluate the profitability of trades.

Options contracts tend to decrease in value as they get closer to expiration. A negative theta means the position will lose value due to time decay, while a positive theta means the option will make money due to time decay. Investors that buy options are negatively impacted by theta decay, since there is less uncertainty around the underlying security's price at expiration and less intrinsic value in the option's premium.

What Is Time-Decay?

What is Options Time Decay?

Out-of-the-Money Options

An out-of-the-money options contract is one in which the underlying security is trading for lower than the strike price if it’s a call option or higher than the strike price if it’s a put option.

In other words, it’s an options contract that that does not yet give the buyer the right to trade the underlying assets.

You’ll have no trouble noticing time-decay in options that are out of the money. That’s especially true as they near expiration.

Why? Because they have less time to hit the strike price. There’s a better chance that they’ll expire worthless.

Things are likely to be worthless in a few days usually don’t sell for a whole lot of money.

That, again, is the reason why options decrease in value over time.

Real Life Example of Using Time-Decay

Let’s say that EURUSD is currently trading at ....... You think it’s going to stay relatively flat in the near future, so you’d like to make some money off of time-decay.

You check out next month’s options chains. You see that the $40.50 call option is currently has a bid of $1.45.

Upon some further research, you determine that’s a good price. So you sell the call option. That earns you a credit of $145 because options contracts are traded in batches of 100 shares ($1.45 x 100 = $145).

Please note: you didn’t buy the call option. You sold it. That means you’re short the option so you make money when its price drops.

Sure enough, Cisco stays flat during the next month.

At options expiration, the stock closes at $40.28 again. The contract you sold for $1.45 is now worth $0.60.

You buy back the contract for $60 ($0.60 x 100 = $60). That means you made $85 on the trade ($145 – $60 = $85).

You won even though the stock price didn’t move one way or the other. Time-decay worked in your favor.

Keep in mind: you would also have made money if Cisco dropped in value. That’s because the price of the options contract would have decreased along with the price of the underlying stock.

So you really had two ways to make money with that trade:

• Natural time decay reducing the value of the contract
• A drop in Cisco price reducing the value of the contract

That’s why that would have been an ideal trade if you were bearish on Cisco. However, you still would have made money even though you were wrong about the price dropping. Time-decay helped turn that trade profitable.

One last point: time-decay and the underlying price aren’t the only market forces that affect the price of options contracts. Implied volatility also affects the price.

In the case of the Cisco trade, you would have lost money if implied volatility spiked after you sold the call option. That’s why it’s a great idea to look at all the Greeks before you place a trade.

Checklist for put buying

Time Decay: Hurts

Volatility: Helps

Potential Profit: Profit can be unlimited in falling market.

Potential Loss: If buy, limited to the premium that was paid. This aspect appeals to

Sensitivity analysis

Delta: Moves towards 1.0 as the option moves in the money

Gamma: Falls rapid as we move into the money or out of the money.

Theta: Time decay will kills this position . Theta will accelerate through life of the trade

Vega: A long put is a long volatility trade. It is aided by an increase in volatility. Vega will increase as the underlying moves closer to strike price.

What can go wrong

poor market analysis; It is essential to trade in the direction of the trend. Put buying

Poor put strike selection

Not enough time: Time decay is the enemy of the put.

If it does go wrong

Practise strong money management. Have a defined stop loss point where you will exit.

It is possible to repair some long positions. For example , if the market stalls and your perspective changes from strongly bearish to moderately bearish, you could turn the position into a bear put spread by selling a put with lower strike price. If your view goes from bearish to bullish, it is possible to convert long put into a put ratio spread.