The purchaser of the option is said to “have the right, but not the obligation” to exercise the option. In other words, if the financial situation would make it profitable for the purchaser to exercise the option, then he or she can do that. If, on the other hand, it would not be profitable for the purchaser to exercise the option, then he or she is not forced to do so. The option simply expires worthless.

Options are used in many different situations besides the stock market and Forex market. A great example of this is in real estate. If you think that the value of a certain piece of property is going to go up, you might purchase an option that would allow you to buy that property at the current market value. If the value of the property does indeed rise while the option is still good, then you can exercise the option and purchase the property for the specified amount.

Let’s take a closer look at options in both the stock market and the Forex market and see what sorts of strategies traders have when they use them.

Traditional Options

Options come in two flavors: the call and the put. A call option, or simply a call, gives the purchaser the right to buy an item at a specified price, known as the strike price. A put option, or a put, allows the purchaser to sell an item at the strike price. These options are widely used in the stock market as both a means of generating cash and as a method of reducing risk in a portfolio. Let’s see some examples.

Let’s say that you own 1,000 shares of XYZ Corp. stock, which is currently trading at $50 per share, and you think the stock price is going to decline to $40 per share over the next month. This puts you in the position of possibly losing $10,000. (Your current value of $50,000 minus the potential value of $40,000 leaves a $10,000 loss.) On the other hand, if you sell your stock now, and the price actually goes up, then you would have missed out on the gain.

To hedge your risk, you could purchase a put that would allow you to sell your stock at $45 per share. This way, if your prediction comes true and the stock falls to $40 per share, then you can sell your stock at $45 per share and cut your potential loss in half. If the stock price rises or stays even, then your option expires worthless and you’re only out the price you paid for the option.

Here’s another example: You have researched ABC Company and think that their stock is undervalued. Let’s say it’s currently trading at $100 per share and you feel confident that it is going to increase by $15 per share in the next two weeks. You want to purchase 1,000 shares of the stock, but it would be difficult to come up with the liquid cash at the moment.

An alternative in this scenario would be to purchase a call on ABC stock allowing you to purchase 1,000 shares at $105 per share. If the stock rises as you predict, then you’ll be able to exercise your option and purchase the $115 stock for $105. In this scenario, you’d actually be able to purchase the stock without having to raise the necessary cash. Any broker would take your option as collateral for the stock purchase and you’d only have to pay the purchase price of the option out of pocket.

Forex Options

The Forex market works very much like the stock market; the main difference is that instead of trading stocks and bonds, you are trading foreign currencies. Similarly, a Forex option works very much like a stock market option; the only difference is that you are trading the rights to buy and sell currencies instead of stocks.

Any transaction on the Forex market involves two currencies. You have US dollars and you want to buy Great Britain pounds or you have Euros and you want to buy Japanese yen. In any transaction such as these, you are both buying and selling. If you are trading dollars for pounds, you are selling dollars and buying pounds. Similarly, any Forex option trading can also be seen as both buying and selling.

When you purchase an option for the Forex market, both the currency you have and the currency you want are specified in the contract. If you wanted to sell dollars and buy pounds, that would be called a USDGBP option, using the standard ISO codes for each of the currencies. This option is both a put on dollars (giving you the right to sell your dollars if the conditions are favorable) and a call on pounds (giving you the right to buy pounds if you wish).

You would purchase a Forex option when you think that the currency fluctuations will let you make a profit but you don’t want to risk all or a large portion of the money in your portfolio. For instance, if you think that the Canadian dollar will become stronger against the US dollar, then you would want to buy a USDCAD put, allowing you to sell your US dollars at the current exchange rate for Canadian dollars. If you currently hold Japanese yen and think that the Great Britain pound will fall, then you would want to buy a JPYGBP put, allowing you to sell your yen for pounds at a favorable exchange rate.

Where To Trade Them

Forex options trading occurs OTC, or over the counter, which means that they are not traded on an exchange. (Actually, a small amount are traded on a couple of exchanges, but the vast majority are not.) Many “mainstream” brokers offer limited access to Forex trading and many of the Forex websites out there offering can’t-miss-strategies are little more than scams. Your best bet is probably to go with an established online broker such as Zecco. Going this route also makes online Forex option trading a breeze.

Finding a personal broker for your Forex option trading can be a bit difficult as there is a limited number of brokers with any real experience in the Forex market. If you want to go with a personal Forex options broker, you can find them out there, but your experience with them may not be the best. It’s generally recommended that you learn enough on your own to make wise investment decisions if you plan on getting into the Forex market.