Bare Essentials

What can Currency Options do for a saver or trader?

Caught in a web of economic stagnation and ultra-low bank interest rates, large segments of global population, which include risk-averse retirees and savers, are facing tough times.

Policy makers in major countries have ensured that banks can no longer provide income to their depositors and that cheap money is available for generating business and economic activities that can generate jobs.

Japanese have learned to live with this situation in last 20 years by becoming active investors in capital markets. Europeans are now turning to capital markets as well. Presently, they are forced to pay fees (because of negative interest rates) to keep their money safe with the banks. About US$3,000 billion of assets in Japan and Eurozone, Switzerland, Denmark and Sweden are charged with negative interest rates.

Currency Options is an unconventional low-risk investment route for income-seeking people. The intention is to help them make their transition to risk taking route comfortable and profitable too.

Currency Options trading can generate quarterly income - a return of at least 40% on a year on the margin deposit placed placed with a broker if the trader can handle the psychology part and spends time on continual management of risk on a daily basis for half an hour.

Currency Options are mostly used by institutional traders using OTC fx instruments with banks acting as counter-parties. Banks make a killing out of them by charging a spread of anything between 5 pips (on a large volume) to 20 pips. Traders on CME Globex currency future options pay between 2-4 pips as spread. Commission charged by deep discount brokers like Interactive Brokers is very low. Both the lower cost of spreads and commission ensure the income generated is lucrative.

A simple trading system can turn a risk-averse saver -- even a high-school dropout and a technologically-challenged lay person -- into a calculated risk taker and end up as a capable risk manager. Just need to understand the core fundamental techniques to get consistent income.

It does not require a person to read currency charts, or feel glued to a computer screen or forecast market direction or trends. Currency Future Options trading is to be run purely as an half-hour part-time home business.

I personally feel it will be ideal for the traders to form a circle of friends or relatives, pool resources and learn to be a risk taker and manager by following the knowledge we will be imparting through the FF posts.

The Bare Essentials

Contract Specifications, tick value, Monetary tick value, Strike Price Intervals and symbols Naming Conventions.

You should acquire basic knowledge about the symbol, contract specifications, minimum tick value, from a broker's web page on Products offered on their platfrom and Chicago Mercantile Exchange (CME).

In spot fx, EUR.USD is the trading symbol for Euro Dollar pair.

On CME, European Currency has its own symbol.

We will be trading on CME Globex (electronic open 23 hours run by CME).

In spot fx, pips and pips value is calculated. In Futures and Future Options it is tick and monetary tick value. Futures and Future Options have different minimum tick increments. Better to access from CME website a product guide and understand all the contract specifications.

https://www.cmegroup.com/trading/fx/files/2015-product-guide-and-calendar-fx-products.pdf

Margin Deposit, Online brokerage account and Commissions Charged

Information should be obtained from your broker :

Initial Margin (good faith deposit given to a broker)

Maintenance Margin (additional margin linked to movement of prices)

How premium earned also is counted as a part of the margin?

You need to be approved for selling (writing) options, which is more of a formality.

Brokerage: You should look for a broker who charges not more than US$3.00 (inclusive of Exchange Fees and all other charges) per contract.

Options terminology

Call and Put

When you buy an option = you pay a premium ($ $) taken out of your account.

When you sell an option = you receive a premium ($ $) into your account

Selling a call option = at expiration of time period you are short (sold) a futures contract

Selling a put option = at expiration of time period you are long (bought) a futures contract

Strike Price, Expiration and Moneyness

The strike price is the price at which the holder of an options can buy (in the case of a call option) or sell (in the case of a put option) the underlying security when the option is exercised. Hence, strike price is also known as exercise price.

The value of an option depends on its strike prices' distance and direction from the underlying market changes. An option can be described as being in one of three states of moneyness depending on its strike price versus the market price:

In-the-money (ITM),

at-the-money (ATM) or

out-of-the-money (OTM)

Unless the strike equals the market rate, the moneyness of a Put option differs from that of a Call option:

http://educateon.com/wp-content/uplo...-Moneyness.jpg

When the strike rate of a long (buy) Put is above the market rate, we say it is in-the-money because the strike allows you to sell at a higher price.

When the strike rate of a long (buy) Call is below the market rate, we say it is in-the-money because the strike allows you to buy at a cheaper price.

When an option is in-the-money (ITM), it is more valuable, i.e. its premium is higher. ITM options are the most expensive to buy, whereas out-of-the-money (OTM) options are the cheapest.

Premium value

When buying an option, the trader pays a premium, the open premium. The premium value changes depending on the changes in the underlying market. The premium of a Put option increases as the market falls. Why? Because the Puts strike price becomes more attractive relative to the market price. The premium of a Call option increases as the market rises. Why? Because the Calls strike price becomes more attractive relative to the market price.

Intrinsic value and Extrinsic Value (also known as Time Value) of In the money options

Assuming the Euro Futures price is 1.08235 (similar to a spot price) the Strike Price of a Call is 1.085 and the premium (ask) is 0139 ticks for the call. The price is more than the underlying price which means the call is in the money.

The difference between the two is strike price (1.08500) - the underlying price (1.08235) = 0.00265

Extrinsic value will be: 01390 (premium) + 0.00265 (Difference between strike price and the underlying price) = 01555 (about 155.5 pips in spot fx).

When two or more options are combined into one strategy, they are called a spread. A spread position is entered by buying and selling equal number of options of the same class on the same underlying security but with different strike prices or expiration dates.

Futures-settled options

For trading Exchange-traded Future Currency Options, the actual physical transaction of the currency pair is not required and you do not have to exercise the option to receive your profit.

Instead, the running profit or loss of the option position is calculated for you and when you close the option trade, or it expires, cash is credited to your free balance (if the option has premium value).

Trades can be closed any time before expiry (during trading hours) to lock-in profit or reduce a loss.

Very rarely a trader takes delivery of the currency futures for speculating further in the Futures Market on the movement of the currencies. Over 95% of option transactions are closed out with an offsetting sale or purchase of the same option, or option expire worthless.