What is the option expiration and how it may affect the Forex market?
Imagine, that you were trading in Forex and suddenly the news about large option expiry comes out. How should you react to this news and what does it mean for the Forex market? Let’s find out.
What is an option?
Generally speaking, an option is a contract, which gives a buyer the right to buy an asset at the pre-determined time and price. At the same time, a seller receives a fee for the contract. A put option grants the right to sell, while call option grants the right to buy. We are not going to enter the depth of the option market, as we only need to find out how it affects the Forex market. To understand this impact, let’s consider the three simple concepts:
- Strike price – is a price at which an option will be granted with profit.
- Expiry date – is a date, when the contract is settled and payments are made. This is one of the most important data in Forex trading.
- Option size – The size of the option’s contract.
The information on opened currency options contracts that are about to expire is usually provided by IFR and distributed by different brokers. FBS shares this data in the «news» section in MetaTrader 4.
So, how can you use this simple knowledge about the currency options in trading?
The easiest way to do it is to use the information about option expiry. Option contract typically equals a sum between 100 and 500 million of the USD. The sums beyond this range are not uncommon. These relatively large sums attract option traders, who try to do anything possible to move the quote rate to the strike price of the option. The situation is especially common if the quote price is about 20-30 pips from the strike price at the time of expiry.
You should keep in mind the difference between the European and the American options.
The European options can only be exercised at their expiration date. That is why their price will be defended harder if the quotes are close to the strike price. It is also recommended to begin with so-called vanilla put or call (non-exotic) option expires. The news sources provide more reliable information about them.
On the other hand, you may exercise American-style options any time you want to before the expiration. As a result, the quote price is less affected during the date of expiry.
There are some perfect conditions for trading option expiry.
- It's 17:00 MT time.
- Option size is bigger than 500 million USD.
- The quote price of the pair is close to the strike price at 15:30.
- There are no major news releases at the same time (for example, the Federal Reserve decision).
So how the Forex option expiry may be applied in your trading?
If the quote price is placed near to the price of the option, option traders may push/pull the quote price in the desired direction.
For example, if there is a European put/call option with the strike price at 1.1230 and the quote price of the pair is at 1.1260 at 14:30 MT time, the quote rate will start to fall to the option strike price at around 15:30 MT. After the news is released, the quote may reverse from the strike price. The quote price will be floating around the level of the strike price for at least an hour, as option traders will try over and over to turn the price to the strike level. To profit from these movements of the price, you need to join the surge generated after another attempt of option traders.
It is important to notice that it is quite hard to build an effective strategy on the option expiries for a Forex trader. But you may use this information in order to understand the current direction of the price.
Conclusion
Forex options help traders to understand the movements of the currency pairs more clearly and even provide a chance to earn money. But don't follow the news about the expiry blindly, as any major event can affect Forex in a more significant way.