By Sean Hyman, Currency Analyst 
www.worldcurrencywatch.com

In 2007, the Philadelphia Stock Exchange completely changed the way normal investors like you and me purchase currency options.

They made currency options easier to buy, easier to sell, but most importantly they made them easier to understand with several improvements including…

• They changed each point value to US$100, so it’s the same as a stock option.
• Expiration dates became the same as stock options (third Friday of the month).

But even with all these changes, many investors still don’t know how to use currency options effectively. That’s a shame considering it truly is one of the easiest ways to break into the currency market – and still shoot for the higher speculative gains.

Fortunately you don’t have to be a mathematician or know how to use a slide rule to play this market. In my view, there are 10 things that are essential to know before you trade them. So let’s take a look at these for a moment.

1. Like in any market, know what you’re trading: When you’re buying currency options, you have six currencies to choose from – and they’re all based in dollars. In other words, you’re betting one of these six currencies will rise or fall against the U.S. dollar. Your choices include the Australian Dollar (XDA), British Pound (XDB), Canadian Dollar (XDC), Euro (XDE), Japanese Yen (XDN) and Swiss Franc (XDS).
2. Do you need any special type of account to trade these? No. You can trade these currency options in any stock brokerage account that has been approved for options trading (which is convenient).
3. Next, you will want to know what these contracts represent. Each contract represents 10,000 units of currency with the exception of the Japanese yen. Its contract size is 1,000,000 units of currency. If you buy one euro contract, you are buying the right to control 10,000 euros vs. the U.S. dollar.
4. These contracts are cash settled. That means that you won’t be delivering any foreign currencies to anyone. Everything is bought in U.S. dollars, sold in U.S. dollars so everything is settled in U.S. dollars. Again, that’s convenient and it keeps it all simple.
5. These options are exercised European style. This means that they may only be exercised on the last trading day prior to expiration (Friday). However, you can always buy or sell the options prior to expiration.
6. What hours can they be traded? They are traded from 9:30 to 4pm EST (regular U.S. stock market hours). Therefore you don’t have to remember any new trading hours in order to trade these.
7. You can get quotes on these options through your broker. You can put in any of the root symbols mentioned above and it will pull up a list of strike prices and months they are offered. Also, the different options have additional letters so each month and strike price can be easily distinguished from each other.
8. Where can you get free currency charts in order to get a feel on what’s going on with the currency and where it’s headed? You can go to the PHLX charts at http://www.nasdaq.com/asp/currency-options.asp or you can also get them through dailyfx.com. Some stock brokerages will also have charts available to you on their trading stations.
9. What type of orders can I execute? You can place call options or put options. Let’s quickly go over the two. If you buy a euro call then it means that you feel that the euro will increase against the U.S. dollar. If you bought an Aussie dollar call, then you feel that the Aussie dollar will increase in value vs. the U.S. dollar. So a call means that you feel the underlying financial instrument will go up in value from its present price. A put means that you feel the price of the currency will lose value vs. the U.S. dollar. So if you feel the British pound will weaken vs. the U.S. dollar then you can buy a put on the pound.
10. Lastly, you need to know how much you are risking on each trade. That’s easy. It’s your option premium. So let’s say the cost is US$1.20 a contract. These contracts have a multiplier of US$100. So US$100 X US$1.20 = US$120 per contract put down as your premium at risk. That is the maximum loss that you could incur on that trade. This goes for both puts and calls. Your premium paid is your max loss. So your risk is easy to figure.

As you can quickly see, these are probably the easiest options to trade out there. Try trading options on futures contracts and you’ll see what I mean.

Also, unlike stocks or futures that have thousands of choices, you’re only watching six foreign currencies (plus the dollar). You only have to deal with buying either a call or a put. You don’t have to open up a new brokerage account. You can hold your Google, IBM and a euro call and a Canadian dollar put all in the same account.

Once you have the basics down, all that’s left is to call your broker…

Best of luck in your trading!
Sean

P.S. My colleagues Jack and JR Crooks regularly predict the biggest currency trends of the year – and tell their loyal readers how to play these trends with currency options. Due to several factors, Jack and JR will be forced to raise the price of their service next week. Join now and lock in today's price before it's too late. Click here for more.