By Sean Hyman

So what are Forex options (aka currency options)? Forex options are options based off of a currency pair in the spot Forex market.

The advantage of an option contract is that you put down little money and control a sizable position. This means you have the opportunity to make large double or triple-digit gains in a very short period of time – just like in the Forex spot market.

The other advantage is currency options trade just like regular stock options on the Nasdaq OMX exchange. So if you’re already familiar with stock options, currency options are generally easier to trade because the “trading lingo” is the same.

Also, unlike Forex trades, you only ever risk your initial investment. For instance, if you paid let’s say US$500 for a specific option contract, you only risk that initial US$500, no matter what the markets do. In other words, your risk is strictly limited.

The downside of an option contract is that every option contract eventually expires, whereas trades in the spot Forex trade NEVER expire. In spot Forex, you just still have to have the margin left to continue to support the position. This is why I personally prefer Forex.

But with that said, let me discuss why some traders still choose to go this route.

To me, the advantage lies in what brokers you can use and where the instrument trades. You can trade currency options through the exact same stock brokerage account that you already have – as long as they trade options.

All you need to do (if you haven’t already) is ask your broker to give you the form to fill out to make the account “optionable.” That means that they give you the proper disclosure about risks, etc. Then you simply fill out the form, and your normal broker can prepare your account to trade options.

Then, you can buy a call or a put on six major currencies: the euro, British pound, Japanese yen, Swiss franc, Canadian dollar and the Australian dollar.

All these options are traded against the dollar by default. So buying a euro call option is like buying the euro/dollar pair (EUR/USD) in the spot Forex market.

Calls vs. Puts: Which to Buy?

You buy call options when you expect the underlying currency to rise. You buy what’s known as a “put option,” when you believe the currency will drop in value (versus the dollar).

These options are traded on the Nasdaq OMX (formerly known as the Philadelphia Stock Exchange) right here in the United States.

So you can trade these through a reputable, regulated stock exchange that you already hold your stocks, ETFs and mutual funds in. So that’s a nice advantage to them.

Currency options are typically the shorter to medium-term instruments used out there in “currency land.” So you use these options to trade short-term trends – lasting from several weeks to several months.