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Generate Income Trade Options
Forex options are very interesting trading vehicles, that offer greater flexibility than futures contracts do. Generally they are not very suitable for very short term intraday trading, however they are very useful in longer term trading. I have found out myself, being a forex futures trader is extremely hard. There are days where market behaviour is really volatile and unpredicted, in currency pairs such the EUR/USD.
The forex futures trader faces the following problems; either too large stop loss order risk, or small and too frequent stop loss order risk. Not knowing where to place the stop loss order on a forex futures contract is very challenging, and can often result in huge unnecessary losses. Then, there’s one more real, less frequent but also big risk, the intervention of the central bank! For example, you maybe short in a currency pair that falls gradually and always makes you a small profit, so it looks like a sure fire trade to continue to sell that currency, and at the same time use large size flexible stops. However there’s a big risk, the central bank of that currency’s country may suddenly intervene in an effort to make their currency correct to what they see as their favourable side. These moves are usually only corrections, but they happen so fast, and are of such great magnitude that even a 700pip stop, may be hit within 2 days! That means a huge 700pip loss, completely unnecessary, only to see the currency drop back down again, and by the time you check your trade, the market has already moved lower 200-300pips, and you have missed it!
Case in point, British Pound VS Japanese Yen.
This is a real trade I once took, I was right that this market would go down, but I got caught in the green circle correction area, I had a large stop in place. I exited the trade myself before the stop level was reached, and I still lost over $4,000 because of this. I always manage to recover my losses in forex. But this was a way too big move. Larger than it looks on the chart, it was enough to completely wipe out a small trading account using such stops, and it could wipe out 50% of a larger account too!
Also not that, using smaller stop orders, contrary to what so called ‘market experts’ would have you believe, it’s downright impossible! If you attempt to use smaller stop loss orders than 700 pips, in forex swing trading….you are almost certain to lose, you lose even if you are right on the move because of the frequent stop running.
The only way to trade the large magnitude currency moves is to use forex options. I wouldn’t use options for minor market moves, but for larger ones, it does make great sense! Particularly these Japanese Yen crosses, are full of last minute surprises and sudden moves that can completely ruin even the best of trading plans.
Forex options tend to trade very similar to stock options, except that here the volatility metrics are almost identical, and behave the same whether the currency pair rises or falls. That is because, when one currency falls, then the other currency in that pair will rise, whereas in stock options volatility works differently. Forex implied volatility is overall a lot lower than in the equity market, and it is affected by various factors, often hard to figure out.
Forex option contracts are widely available today, and the screening and trade simulation tools offered at Analyzetrade.com can be used on these. For example, the option for the EUR/USD pair is found under the symbol EUI in these platforms. It is relatively easy for an educated trader to use these tools, even new traders can start using them immediately for simpler trading strategies.
Using both Futures and Options in Forex Trading
One way to combine the best of futures trading and the best of options trading, is to actually use both! Despite what everyone tells you, by combining both types of trading vehicles you can achieve a significantly lower risk/reward ratio!
Types of options used in forex: There are many different types of options offered in forex, on one hand you have what is known in the options industry as vanilla options, and these are simply the well known stock option-like contracts. On the other hand, there are other, more complicated option contracts that belong to the family of exotic options, these offer even greater flexibility than vanilla options!
For example, an exotic option allows you to profit if the currency pair in question stays within a given price range, and it doesn’t touch either barrier throughout the contract term, while another exotic option allows for a profit, if a given, predetermined level is touched!
Generally, options are a great tool, and even plain vanilla options are enough for my swing trading purposes. In the case of the trade mentioned above, I would have been better off using an option rather than the futures contract, because a forex option contract will not get you stopped out of the market! In fact, it could absorb the entire correctional move at no extra risk, the only risk is the premium paid, and then, once the market has fallen again, the option will be in profit!
Looking back now, at many of my forex trades, I realize how naïve I was about futures trading. And even though I managed to win back all my losses, it is evident that, had I used a more sophisticated strategy, involving both futures and options, and using them properly… It would have saved me many days of stressful living and many $1,000s in unnecessary losses.
The naïveness is in the fact, that we have been told to believe in the so called 1/3 risk reward ratio and the like. Except in the forex swing trading strategies, no matter how you place your stops, a tight stop strategy will get you stopped out way too often. I remember getting stopped out on EUR/USD almost in every trade, for a whole 2 week period, even though I used 300 pip stops. It just doesn’t work!
It is possible to achieve 1/3 and even 1/5 risk reward ratios, but only when you combine futures and options, such as using large, massive stops on the futures and a separate option contract to hedge the loss of the stop.
Analyzetrade.com provides just the right tools for the job, analyzing the trade, and finding a way that will really simulate different market scenarios and trades until you find your best solution. One that will be better than a lame, simple outright futures contract!
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