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Currency Options University – Part 4

Patrick Ceresna
November 22, 2019
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5 minutes read
Currency Options University – Part 4

Directional Trading with USX Currency Options

Our focus in Part 4 of the series is to demonstrate how USX currency options can be used for directional trading through the direct purchase of a call or put option. Options offer investors a way to buy a long position with a defined risk (limited to the cost of the option), while providing speculators a means to take on highly leveraged positions without needing to manage their risk with tight stop losses.

Bullish on the U.S. Dollar

In our first scenario, our investor is bullish on the U.S. dollar, anticipating a material rise into the year-end.

• Current price: 1.3080

• Target price: 1.3500 or (135 cents)

• Anticipated time needed: 60 days

• Desired exposure: $100,000

Based on these criteria, our investor focuses on buying the December 2019 expiration and, in particular, the at-themoney 131.00 strike call with an ask price of 1.03, as shown in Table 1.

TABLE 1
USX – Options on the US Dollar (130.8 USD/CAD)

Source: Montréal Exchange

If you need to refresh your memory on contract specifications, see Currency Options University – Part 3

TABLE 2
Breakdown of buying the call

Source: Big Picture Trading Inc.

As per Table 2, our investor makes a $1,030.00 cash outlay to control a notional exposure of $100,000.00 in U.S. dollars. Although the investor is able to sell these options at any time prior to expiration, for sake of simplicity we will assume that he or she holds them to maturity. Now let’s look at the investor’s profit/loss position at various closing prices.

TABLE 3
Option value at expiration

USD/CAD BFIX

Intrinsic Value (BFIX – strike)

Net profit / loss

Profit/loss on 10 USX calls

135.00

4.00

2.97

C$2,970.00

133.00

2.00

0.97

C$970.00

131.00

0.00

-1.03

-C$1,030.00

129.00

0.00

-1.03

-C$1,030.00

The key takeaway here is the asymmetry of the outcomes.  Even though the table ends at 135.00, our investor has unlimited upside potential if the price of the U.S. dollar continues to appreciate beyond the target.  At the same time, the maximum risk of loss is defined by the cost of the call options.  This gives the investor more certainty when sizing the trade.

Alternative to Stop Losses

Another consideration is that leveraged traders tend to use Forex markets with stop loss orders as their risk management tool.  This may work for some traders, but many often underestimate intraday volatility, seeing their positions hit the stop loss level and then watching the currency resume the desired trend.

Bearish on the U.S. Dollar

In our second scenario, our investor is bearish the U.S. dollar, anticipating a material decline into the year-end.

• Current price: 1.3080

• Target price: 1.2700 or (127 cents)

• Anticipated time needed: 60 days

• Desired exposure: $100,000

Based on these criteria, our investor focuses on the December 2019 expiration and, in particular, on the put with a 130.50 strike and an ask price of 1.00, as seen in Table 4.

TABLE 4
USX – Options on the US Dollar (130.8 USD/CAD)

Source: Montréal Exchange
TABLE 5
Breakdown of buying the put

Source: Big Picture Trading Inc.

In this second example, our bearish investor makes a $1,000.00 cash outlay to control a notional exposure of $100,000.00 in U.S. dollars, to the downside.  Now let’s take a look at the investor’s profit/loss position at various closing prices.

TABLE 6
Option value at expiration

USD/CAD BFIX

Option profit (strike – BFIX)

Net profit / loss

Profit/loss on 10 USX puts

132.00

0.00

-1.00

-C$1,000.00

130.50

0.00

-1.00

-C$1,000.00

129.00

1.50

0.50

C$500.00

127.00

3.50

2.50

C$2500.00

Again we see the same asymmetry – an unlimited profit potential with a very specific level of risk, defined as the $1,000.00 capital outlay (the cost of the put options).

Conclusion

Currency options are one of many different tools used to participate in the currency markets. If it is important to take a leveraged position with high conviction while defining your risk in terms of a very specific worst-case loss, then you should consider implementing the trade with USX options.

Disclaimer:
The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.

Patrick Ceresna
Patrick Ceresna http://www.bigpicturetrading.com

Derivatives Market Specialist

Big Picture Trading Inc.

Patrick Ceresna is the founder and Chief Derivative Market Strategist at Big Picture Trading. Patrick is a Chartered Market Technician, Derivative Market Specialist and Canadian Investment Manager by designation. In addition to his roll at Big Picture Trading, Patrick is an instructor on derivatives for the TMX Montreal Exchange, educating investors and investment professionals across Canada about the many valuable uses of options in their investment portfolios. Patrick is also co-host to the MacroVoices weekly podcasts. Patrick specializes in analyzing the global macro market conditions and translating them into actionable investment and trading opportunities. With his specialization in technical analysis, he bridges important macro themes with the attempt to understand when those trends are beginning and understanding where they likely to go. With his expertise in options trading, he seeks to create opportunities that leverage returns, while managing/defining risk and or generating consistent enhanced income. Patrick has designed and teaches Big Picture Trading's Technical, Options and Macro Masters Programs while providing the content for the members in regards to daily live market analytic webinars, alert services and model portfolios.

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