Learn To Trade Exotic Currency Options

Currency Options are used by companies as risk management tools. What are Options? Simply stated, it is a contract that gives the buyer the right but not the obligation to buy an underlying asset under specific conditions on payment of a premium.

The buyer may or may not exercise the right. However, if the buyer of an options contract exercises his/her right, the seller is obligated to perform.

In all foreign currency transactions, one currency is purchased and another is sold. Consequently, every currency option is both a call and a put option. A call conveys the right to buy the underlying currency at a specified price. A put gives the buyer the right to sell at a predetermined price.

Why options are important as a risk management tool. Suppose a Japanese company is going to make the payment for its import of raw materials in 3 months time in USD.

The Japanese company can stay unhedged and purchase US Dollar in prevailing spot rate in three months time. On the other hand, it can hedge by buying USD forwards or it can use an options strategy.

One of the strategies available to the Japanese company is to buy JPY put/USD call option. The effect of buying the JPY put option is to put a ceiling on the cost of imports in case JPY depreciates. The exporter limits the cost to a maximum while not limiting the minimum. Now lets discuss five exotic options that you can trade to make profits under different market conditions.

Digital options are inexpensive, simple and easy to trade. If you believe the EUR/USD rate is going to be above 1.0900 after two months but you are not sure about the timing of this move, buy a digital option. If after two months, the EUR.USD rate is indeed above 1.0900, you get your predetermined payoff. If not, your digital option will expire and you with lose only a small premium.

One Touch Options are perfect for those traders who believe that there will be a retracement and the price of a given currency pair will test a support/resistance level. The one touch options pay a fixed amount if the market touches the predetermined barrier level.

A No Touch Option is a great way to profit from a trending market. The no touch option pays a fixed amount if the market never touches the barrier level that you choose. All you need to do is to determine the desired payoff, the currency pair, the barrier price and the expiration date.

A Double No Touch Option is perfect for you if you have the successful record of identifying and profiting from breakouts. But you have always lost money when the market is ranging. On the other side, you can use a Double One Touch Option if you know how to pick the tops and bottoms in a ranging market. However, you have always lost in a breakout market.