FX fundamentals trading with options

Trading the Forex market in any manner has many advantages over other markets (such as equities). It is highly liquid, very large, almost impossible to manipulate, its volume driven mainly by commercial trade need (not speculation), and the relevant data is transparent and easily available (except trade volume). However, there are some real pitfalls. If we�re wrong directionally and the market finds us, losses can be severe, even at lower leverages. A modicum of volatility is good for trading, as movement is what sustains a market. However, during the last year volatilities have been enormous. With a 24/5 market, you can�t always be there to monitor positions. The use of stops can prevent a blown account, but they also lock in losses, and unscrupulous counterparties may artificially hit them.

Trading Forex with [U]options [/U]preserves much of the advantages of trading Forex, and eliminates some of the downsides:
There is no leverage in the purchase of options. Sleep at night
There is no drawdown beyond the premium. Sleep at night
There is less time involved (no need to monitor positions often)
Trading with options avoids the paying of interest on leveraged positions- of special interest to Muslim investors following Sharia law, who cannot pay interest (or even receive it on the Carry).

The upside is large and can return multiples of the premium. The two disadvantages to options are 1) unlike a trade in the underlying asset, options are time-limited and 2) the spot must move enough to cover the premium and then an additional amount for a profit to be made. A trade in the underlying spot profits as soon as it moves enough to cover the broker spread.

Bank proprietary traders, hedge funds, family funds and real money investors (endowment funds etc), which have a lower risk profile, and yet strive for and often achieve real returns north of 25%+/year, do not trade on a day to day or even week to week basis. Whether or not they are trading RV (relative value), global macro or directionally, they trade using fundamentals, over a horizon of months to years. If we want to emulate their success and limit our risk, we should emulate their methods, at least partially.

As 2008 has shown, even these pros get sideswiped. Hedge funds on average decreased 18% in value in 2008. Some university endowment funds lost value for the first time in history. And of course, LTCM in 1998 showed that even the best and brightest can lose without a true risk management system in place (one that accounts for �fat tails�- better known as excess kurtosis.) Whatever method we use should still be able to profit, or at least limit losses during such �Black Swan� events.

The usually high volatility of Forex lends itself very well to options. Once an option is in the money (ITM), the value moves nearly 1:1 (excepting the time value) with the spot. Our downside risk is limited to the premium already spent. No further drawdown to your account is possible. No matter what the spot does, we can sleep at night.

Another advantage is that the need for stops is moot- if the spot moves away from the strike, the option value drops. However, as long as there is still time value, if the spot recovers, so does the value of the option. This is a key advantage of options- short term price action does not imperil our equity.