We would advise traders to first trade spot prices and once they are well versed with that, they can then graduate to options which are great instruments to trade with as long as you know what you are doing. If you have a forecast for EURUSD, it is easy for you to trade it without a time limit (which is the privilege that spot prices give you) rather than trying to trade it with a time limit which is what options make you to do. So options have the advantage of unlimited profits but they expire within a specific time limit and if the traders can add this time dimension to their trading, they can easily master the options concept irrespective of which instrument or market they trade in.
There are a variety of options trading strategies that you can use but here we list some of the best keeping both the risks and the returns in mind while discussing them
Covered Call – One of the simplest and most straightforward strategy is the covered call where you sell (write) a call options and at the same time, you buy the instrument in the spot market as well. Let’s say that you have a EURUSD forecast that says that it will continue in a range for the rest of the year, then you can buy EURUSD in the spot market and sell the equivalent amount in the form of calls in the options market. By writing the option, you protect yourself of losses when EURUSD falls and you also gain that little extra money which you get as the premium when you write the call. The risk is practically zero and you use this when your EURUSD forecast is neutral.
Bull Call Spread – In this, the trader buy options at a particular strike price and sells the same number of options at a different strike price. Everything else in this strategy, like the instrument and the expiry month, is the same. The trader takes this strategy when he is bullish about the underlying so that he makes more by the calls that he has bought than what he has sold. It’s the same with Bear Put spread as well if the trader is bearish with the underlying.
Long Straddle – This strategy is used when the trader is sure that the price of the underlying will move significantly but is not sure in which direction it would move. So, he buys both a call and a put option with the same strike and expiration month. So, when the underlying moves more than the total premium that he has paid, he begins to make a profit.
Iron Condor – If you have a fairly trustworthy analysis of EURUSD but still want to protect yourself with low risk, then this strategy might be useful though it is pretty complicated. This strategy involves a combination of 2 different strangles while holding both long and short positions on the same. As it sounds, this strategy is a complex one and should not be used unless the trader fully understands the same.
Writing Calls – This is a fairly straightforward options strategy but fraught with risk. If your forecast for EURUSD says that the price will remain neutral or go down, then it would be useful to write an out of the money call option. As long as the strike price is chosen to be far away from the current price and the forecast is proved correct, you should be able to make some regular income using this. But as you can see, the risk is unlimited in this strategy.
Collar – This strategy is just a covered call position but you just add a put as well into the mix so that it protects the trader against the fall of the underlying. This also causes the returns to become limited but for those who are concerned about the risk would gladly take this strategy.
- Strangle – When the put in the straddle has a lower strike price than the call and when both are out of the money, then it is called a strangle. Again, the potential losses could be unlimited and so this kind of a strategy should be used only when the trader forecast for the underlying, say the EURUSD, is that it will move a lot during the expiration month.
We have listed out a variety of options strategies from the most conservative to the most risky ones. As any seasoned trader and investor would know, the return is always proportional to the risk as well and it is up to the investor to decide what kind of a risk he can take and then opt for the correct strategy and ensure that he executes it correctly as well so that he can enjoy good profits with little effort which is what options provide you.
This is a guest article from FX Empire.
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