In addition to signals, you can use another equally useful tool in forex trading. When used wisely, options can mean a world of difference.
What is an option? Essentially, an option is an agreement or contract that gives the power to trade a currency at a pre-determined, specific price. It is so called because this power is optional – the holder of the contract is not obligated to use it.
In the foreign exchange market, two types of options exist.
1. Call options
A call option gives the power to buy a currency at a specific price. When the underlying stock rises, its value increases. In short, what you need to do is to buy a call option on a stock when you predict that the price of that stock is about to rise.
2. Put Options
A put option, on the other hand, is the power to sell money to someone else at a pre-determined price. You buy a put option if, in your prediction, the stock in that currency is about to fall.
The point is this: you buy or sell the stock, make a profit by buying options, and then in turn sell those options to someone else for a profit.
At the end of the contract, the value of those options will be what is indicated in that contract. Other than that, at any time the value of that option is the current value in the market and the holder believes he will make a profit. He has foreseen that his call option will go up and/or his put option will go down.
It may seem complicated at first, but once you get a handle on the principles, it all makes sense. Remember, calls will go up and puts will go down.
Now add the concept of leverage to the concept of options and the potential for profit will be amazing. Leverage is the opportunity to borrow your broker’s assets to trade currencies. So in effect, if you can buy puts at the right time and sell them at the right time, your profits will be even greater.
Companies also use options to reduce the risk of trading forex. Think about it, you can buy without being bound by the current market volatility rules. It simply adds a new dimension to forex trading. Whether the underlying stock is up or down, there is the potential for profit. Add to that the power of leverage and then we can make even more profits. This only works if we can correctly call the currency stock movements in our mind.
And this is just the tip of the iceberg. The idea becomes even more complicated when we calculate the intrinsic value of the stock and how the company uses options to protect itself from risk. However, the basic principle remains the same: it is possible to get a greater return by trading options rather than stocks. On the flip side, leverage can also put you at great risk.
That’s why you must first have a sound forex trading strategy and that you are confident enough to judge changes in stock values. Once you are ready, then the possibilities for huge profits will all open up for you. Learn more about the options and forex trading process; they will be your main weapon for market success.