Updated on July 18, 2023
Options trading is part of the derivative or the secondary markets. Traders can choose from the available option types based on their trading strategies and market dynamics. The different option types available in options trading are given below.
Meaning of Option Types
Options are financial contracts that grant traders the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specific timeframe. They are divided into two primary types: call options and put options.
Call Options – A call option provides the buyer with the right to purchase the underlying asset at a predetermined price, known as the strike price, on or before the expiration date. Call option buyers anticipate that the price of the underlying asset will increase, enabling them to profit from the price difference between the strike price and the market price. If the market price remains below the strike price at expiration, the call option will expire without value.
Put Options – Conversely, a put option grants the holder the right to sell the underlying asset at a predetermined strike price on or before the expiration date. Traders acquire put options when they anticipate a decline in the price of the underlying asset. If the market price exceeds the strike price at expiration, the put option will expire worthless.
How are option types important in the currency market?
Hedging – Currency options allow companies to hedge against currency risk by protecting themselves from adverse exchange rate movements.
Speculation – Currency options enable traders to speculate on the direction of exchange rates, either by purchasing call options for expected increases or put options for anticipated declines.
Flexibility – Options provide traders with flexibility in choosing strike prices and expiration dates that align with their market expectations.
Limited Risk – Currency options offer limited risk, as the maximum loss for an option buyer is the premium paid.
Volatility Trading – Currency options can be used to trade currency volatility itself, with traders profiting from increased option prices due to heightened volatility.