How Options Work (part 1)

Options are an extremely versatile trading instrument. Since options cost less than the underlying asset (in this case the currency pair), they provide a high leverage approach to trading that can significantly limit the overall risk of a trade. Simply put, option buyers have rights and option sellers have obligations. Option buyers have the right, but not the obligation, to buy (call) or sell (put) the underlying currency at a specified price until the expiration date of the option. There are two kinds of options: calls and puts. Call options give you the right to buy the underlying asset. Put options give you the right to sell the underlying asset. It is essential to become familiar with the inner workings of both. Every strategy you learn from this point on depends on your thorough understanding of these two kinds of options.

There are no margin requirements if you want to purchase an option because your risk is limited to the price of the option.  GCI's online trading system allows for buying options and closing out these positions.

To trade options, you must be acquainted with the select terminology of the option market. The price at which an underlying currency can be bought or sold if the option is exercised is called the strike price. Options are available in several strike prices above and below the current price of the underlying currency.

The date the option expires is referred to as the expiration date or Expiry. The option Expiry is specified by the GCI client before the option is priced and purchased.

The price of an option is called the premium. An option's premium is determined by a number of factors including the type of option (call or put), the current price of the underlying currency pair, the strike price of the option, the time remaining until expiration, and volatility. An option premium is priced on a per lot basis.  Buying an option creates a debit in the amount of the premium to the buyer's trading account.  GCI's trading software will quote the premium in terms of both the "Option Price" (the cost in pips of the option) and the "Option Cost" (the total dollar cost of the option).

How Options Work Review

• Options give you the right to buy or sell an underlying instrument.
• If you buy an option, you are not obligated to buy or sell the underlying instrument; you simply have the right to do so.
• Options are good for a specified period of time, after which they expire and you lose your right to buy or sell the underlying instrument at the specified price.
• Options when bought are done so at a debit to the buyer.
• Options are available in several strike prices representing the price of the underlying instrument.
• The cost of an option is referred to as the option premium. The price reflects a variety of factors including the type of option, the current price of the instrument, the strike price of the option, the time remaining until expiration, and volatility.
• Options are currently available on all major currencies in GCI's Standard Forex and Mini Forex trading accounts.

Next:  How do Options Work (part 2) >