If you want to trade currencies and you want to limit your risk options are a great vehicle to use, as they allow you to risk only the premium you pay for the option which gives you limited risk and unlimited profit potential. Furthermore they allow you to ride out price spikes against you without getting stopped out, before the move comes back your way. Although options are not very popular with novice investors they should be and in this article we look at why and how to use them correctly.

When you buy an option you buy a strike price at where when the option expires, to make a profit you must be trading above this price on a (call option) or below the price if you are looking for a decline a (put option) the further away the strike price is from the actual price the cheaper the option will be.

Currency options offer a lot of advantages for traders and the main two are limited risk and staying power but its a fact that 90% of all options expire worthless which would seem that you have little chance of winning with them but you can win with them, you just need to follow the points below and avoid the mistakes of the majority.

Let's look at a simple example to show you the major mistake the novice option buyer makes.

You're betting on a horse race and you have a 2:1 favourite and you have a 20:1 outsider which one is the better bet in terms of making a profit? If you bet on the outsider, you have bigger possible return but betting on the favourite gives you a better odds of winning.

Trading the Odds a Brief Intro

How often do you see a betting shop go out of business? Not very often they know the odds of success and the betting odds on horses or anything else they offer odds on reflect this. They might get caught out now and then but mostly they get the odds right.

The gambler loves betting on the outsider because if his horse comes in he makes a killing but the key word is if – he doesn't win long term.

Currency Options Getting the Odds on Your Side

In currency options though traders continually take the outside long shot bet and are motivated by the if an option which is bought a long way from the current price ( out the money) the gain will be huge in relation to the premium paid. Furthermore, to make the option cheaper they buy options with very little time to expiry and doing this is like betting on the outsider in a horse race.

The premium is so cheap and the potential gain is so large because the option has little chance of trading in the money. If you want to put the odds in your favour you need to buy options with less potential in gains but greater odds of success and if you do this, you can make huge gains over the longer term

If you want to trade currency options like a pro just remember the following:

Never buy out the money options by at the money options or in the money options and make sure you have plenty of time on your side and never buy less than 3 months. As an option gets near to expiry the time decay increases and kills the option premium so make sure you have time on your side when you buy.

Final Words

Buying in or at the money currency options with a lot of time value reduces your profit potential. However, potential that does not become profit to you is just that – potential and you can't spend potential. Keep in mind the horse betting example we quoted earlier - Do you know ANYONE who bets on the outsider in races, wins consistently and makes huge gains long term? I don't.

Use options sensibly and trade the odds and they can be a valuable tool in your currency trading strategy and can make you some great gains long term. The simple tips we have given you here, will get the odds on your side and make you a lot of money and that's what all traders want – so try using currency options and you will be surprised at what a great trading vehicle they are.