For example, you are trading on Forex and suddenly get notification about the expiration of an option. How do you react to it and what are the implications for the Forex market? Let’s find out.
What are the options?
In general, an option is a contract that gives the buyer the right to buy an asset at a predetermined price and time period. At the same time, the seller receives a fee for the contract. Put option contracts give you the right to sell, while Call options give you the right to buy. We will not go into detail about the options market here because we just need to understand how it affects the Forex market. For that, let us consider the following three simple understandings:
- Strike price (target price): the price at which the option will be able to make a profit.
- Expiry date (expired date): the date on which the contract was concluded and payment was made. This is one of the most important data in Forex trading.
- Option size: option contract size.
Information about options contracts of the opened currency which expire soon is usually provided by the IFR and passed on by the brokers. FBS provides this data in the “News” section of MetaTrader 4.
So, how to apply this simple understanding of currency options in trading?
The easiest way is to take advantage of information about the validity period of the option. Options contracts usually range from 100 to 500 million USD. Numbers greater than this range are unusual. The relatively large number always stuns options traders who try to do everything to move the quote rate (quotation value) to the strike price of the option. Moreover, this situation is common when the quote price is between 20 – 30 pips from the strike price at the expiration date of the option.
You have to keep in mind the difference between European and American options.
European options can only be exercised on the expiration date. Therefore the price tends to be held stronger when the quote price is close to the strike price. It is also recommended to start with the so-called vanilla put or call (non-exotic) option term. The news sources provide more credible information about this option.
Meanwhile, you can exercise American-style options at any time within the term of the option contract. That way, the quoted price will be less influential when it expires.
There are several conditions that are perfect for trading options on the expiration date.
- 17:00 MT time.
- The option size is greater than 500 million USD.
- The quote price of the pair is close to the strike price at 15:30.
- There are no significant news releases at the same time (for example, decisions of the Federal Reserve).
So how can the validity period of Forex options be applied to trading?
If the quoted price is close to the option price, the options trader can push/pull the quote price in the desired direction.
For example, if a European Put/Call option is close to the strike price at 1.1230 and the quote price of the pair is at 1.1260 at 14:30 MT time, the quote rate will start to drop to the strike price of the option at around 15:30 MT time. Once the news is released, the quote rate may reverse from the strike price. The quote price will float around the strike price level for at least an hour as the options trader will continue to try to change the direction of the price to the strike price. In order to profit from this price movement, you have to follow the wave generated after another trial of options traders.
It is important to note that it is not easy to build an effective strategy on options trading on the validity period of a Forex trader. But you can use this information to understand the current direction of the price.
Forex options can help traders understand the movement of currency pairs more clearly, and even provide opportunities to make money. However, it is not recommended to follow news releases blindly, as any important event can affect Forex in a more significant way.