A recent addition to the forex market within the last few months has been forex options (to retail traders anyway). In this article we will explore this new derivative and give our opinion on the matter. We will also look at the two major forex options broker on the internet today and give our pros and cons to both.

If you do not know what an “forex option” is may I suggest that you skip this section as it assumes the reader has some prior knowledge in this instrument (there are plenty of free resources on the internet that can help you learn).

Forex Option Characteristics

Forex options have several unique advantages that normal conventional stock/future options do not. Here is quick list of some of the characteristics of forex options:

You can determine your own exercise price
Options can expire at two different times of the day

Apart from those two characteristics every other aspect of the forex option is similar to its stock/future option counterpart.

Unfortunately these characteristics can more be a disadvantage to the average trader than would otherwise seem. Besides the obvious question of: Which strike price should you use? There is another more subtle enemy that most new options traders will not know about.

If you have some experience with options in the stocks and commodities industries you will well know that there are certains entities responsible for creating the bid/ask spread of the option. These entities are generally labelled as market makers. Now market makers aren’t renowned for being nice and giving away money (don’t forget they need to make money too, otherwise they’re just not in business), so when you trade with a market maker in the options market you are probably best to use round number strike prices. If you use obscure strike prices it will probably just be between you and the market maker - and have a guess who will not want to lose in this deal?

Still don’t quite understand? That’s alright. Listen carefully: a market maker provides the bid/ask spread of the option you are wanting to deal in. As you may or may not know there is no market depth with the forex option - you don’t even know if other people are out there purchasing/writing the same option you are about to transact in. So, if no “market” exists bar the one that your “friendly” forex option broker is quoting, how do you know if they are not inflating/deflating price?

Well firstly they’ll need to know what you’re doing? If they inflate price then you can write the option and wait for the forex option to fall back to “fair” price and collect the premium. If they deflate price you can buy the option and wait for the price to rise back up “fair” price and collect the profit.
Excellent!

You’re understanding so much faster than I thought! Keep reading… the clincher is just around the corner.
Let’s say that they quote a “fair” price with your transaction, not knowing if you are going to buy or write. Once you are in, they now know what your transaction is. Now who is to say whether or not they should start quoting an unfair price according to your position?

There’s no regulated forex options exchange to check your options price against, and who’s to say that the price you have on your monitor is the same that other people are receiving too?

You’re now at their mercy.
No thanks - not for me.

Who offers forex options?

Saxobank is one of two forex brokers that enable forex options trading on their platform. They offer bid/ask spreads on their forex options and their only trade restriction is that you must deal in forex options that have no less than 7 days prior them expiring (they all expire at 1400 GMT on the day of expiry) and no later than 7 months. The multiplier for their forex options ranges from 250k to 50million.
Quacks Like a Forex Option, But Is It?

But the second of two forex option brokers that we reviewed had us a little concerned about whether the instruments should really be termed “forex options”! This forex option broker being Refco Spot.

Refco Spot seem to make forex options trading much more easier for those new to options trading. All you need do on their browser-based platform is input:
The amount of money you would like to make…
On the currency pair you wish to speculate on…
To hit (or not hit) a certain price…
In the amount of time you set

When your requests have been entered Refco will then display a cost to complete your trade. Depending on the type of trade you have requested the cost can range from US$10 to as much as the amount of money you wish to make (which will leave you with zero net profit of course). However, the benefits of this type of trading is that you know what your worst possible loss can be if you happen to get it totally wrong.

BUT, nothing is as rosy at it seems, upon further investigation we found quite a few imposing restrictions, here are some of them:
Trades can only be placed no less than 12 hours prior to expiry and no more than 1 month away (forex options expire at 10AM or 10PM NYEST each trading day)
The smallest amount that you can place to make is US$100, the largest US$10,000
You cannot reverse or exit an open trade (you will just need to enter into a new one)
Barriers (price targets) for the forex options can only be set to as low as ~60 pips away from the current price and as far away as ~300 pips
Be mindful that the barrier price is Refco’s bid price - if the bid price hits your barrier then the trade is completed
All pay-outs are made at expiration

To us, Refco’s options platform seems more like a gambling/spread-betting platform. Although they might derive their cost using an options calculator, the ability to not be able to exit out of positions seems to give the feel that we have more of a gambling facility than a trading facility. Take it whichever way you will. In any case, it seems Refco are in some trouble now, so there's no point in Trading with them, they're the sister company of FXCM.

Whinge Whinge Whinge

Well so far we’ve done nothing but complain, what changes would we like to see before we would even consider looking at forex options again?

Here are our recommendations for Saxobank-style forex option brokers (we don’t care to comment any further on Refco style option brokers):

1. A global regulated exchange of the forex options market (market makers generally don’t have our best interests at heart so we need to make sure that we are receiving a “fair” price!)
2. Volume and Open Interest data of option contracts (we want to see that others are involved with the option we are dealing with - i.e. there’s not just a market provided by the market makers)
3. Guaranteed stops (although not really a prerequisite, but something that would be favorably looked upon)
4. Trades can be placed right up to the day and time of expiration

Are forex options all that they are cracked up to be?

We don’t think so, not yet anyway.
Maybe when more market makers enter this area we could see better improvements, but for the time being I would encourage others to continue trading the spot market than forex options.