Forex option trading is a financial instrument, which serves for both hedging and speculating. In the past, only the large financial institutions would use Forex option trading for hedging. However, this trading option is also available for individual Forex traders. There are advantages and disadvantages to Forex trading, just like any other trading strategy. This is a very liquid financial tool and can be very risky. Forex option buyers are called holders, and option sellers are called granters.

A Forex option buyer has a right to exchange a specific amount of currency at an agreed rate at a specific date. The buyer is contracted to pay the seller a premium, before the buyer even purchases the option. This is the only obligation of the buyer. This limits the liability of the buyer. The seller, on the other hand, has two possibilities with Forex option trading - either to buy back the foreign currency contract prior to its expiration date or to hold it until it expires.

So what exactly happens when you buy a Forex option? Essentially, you are opting for a fixed price of the transaction. Forex options have a fixed currency amount with a fixed expiration date, rather than being tied to the markets' fluctuations.

This may seem surprising to new traders, but forex options are not usually exercised. Most of the time the options are not exercised by the option holder; the options are often offset until they expire. If the option does get exercised, a spot position is assigned to the option holder. There is also a small possibility that an option will expire worthless, if the strike price is lower than the purchase price at the expiration date.

As previously mentioned, there is a fixed price assigned to Forex options. The beauty of this caveat is that it offers protection for an option holders capital. If the market takes a turn for the worse, you will not lose all of your capital. But we're not trading the Forex market to limit losses though. Let's focus on how you will profit. When the strike price is higher than your initial purchase price you pocket the difference. However if the strike price is lower than the initial purchase you will incur a loss.

Forex option trading is exclusively availabe in the international markets, because it's a hedging instrument. This strategy is generally risky, but it also generates higher returns when you know what you're doing.

Types of Forex Options

There are two types of options in Forex option trading- call options and put options. Call options give a trader the right to buy currency, and put options give the trader the right tosell currency. Both of these options generally change in response to volatility fluctuations, i.e. if the volatility falls, the prices of both options also fall. There are common and customized Forex options, respectively called "plain vanilla" and exotic.

In order to protect yourself from potential losses, it is better to follow general safety guidelines:

1. Place a small portion of your working capital into your option trading strategy.

2. Limit your trading. Monitor the market and wait for proven signals to enter the market, execute your strategy, and generate your profits.

3. Test out your option trading strategies in your demo account first. As you get a hang of everything and become confident in your option trading strategy, it's time to enter the market.

Forex option trading is an additional Forex trading strategy. In order to become better diversified, you may wish to learn more about Forex option trading in addition to regular Forex trading.