Forex Directory

Vanilla Forex Option Glossary


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American Style Currency Option - An option that may be exercised at any time up to and including the day of expiration.

At-the-money (ATM) Option - Used to describe an option whose strike price is roughly equal to the current market price of the option.

Boston Option - An option whereby the premium is payable on maturity and not up front as is usually the case. The LIFFE exchange uses this approach on many of their contracts.

Butterfly Spread - A strategy to occupy both sides of the market using spreads. It involves going long a bull spread and long a bear spread.

Calendar Spread - This involves buying two options with the same strike price but different expiration dates to take advantage of the increased rate of time decay on the shorter dated option. Example, long a june $/yen call and short a $/yen february call option.

Collar - This is a strategy commonly used in hedging. It involves purchasing a put and selling an otm call to pay for the put option purchased. Of course, the reverse can be constructed as well with the purchase of a call and sale of a put option.

Delta - Is a measure that indicates the change of an option price relative to a change in the currency price. A delta of .5 would indicate that the long option holder is long the equivalent of 1/2 of a futures currency contract.

Delta Neutral Spread - Refers to a market position constructed with options that result in a neutral position, without bias. By matching the delta of a put option with the delta of a call option, your net delta should equate to zero. Thus, you would be unaffected by small price movements. Of course this position would have to be adjusted if the market would move significantly in any one position. Some market players sell both calls and puts equally and try to achieve a zero delta and thus try to capitalise on time decay and/or lower implied volatility.

European Style Currency Option - An option that may only be exercised on the expiry date, with settlement usually two days later, in keeping with the spot settlement cycle.

Gamma - A term used to denote the measure of change of the delta of an option.

Implied Volatility - Is a measure of an option volatility. The volatility of an option reflects the market expectation of a possible future outcome. An analogy may be the fixed "odds" for a football match which suggests what the public feels the outcome may be. Implied volatility is also significantly influenced by the market maker.

In-the-money (ITM) Call - A call option with a strike price lower than the present market value of the currency. Thus, you would be able to purchase the currency for a price lower than the market value.

In-the-money (ITM) Put - A put option with a strike price higher than the present market value of the currency. Thus, you would be able to sell the currency for a price higher than the market value.

Intrinsic Value - This refers to the difference between an in-the-money call/put and the strike price.

Long Straddle - An option market position that consists of purchasing equal units of calls and puts with the same strike price and expiration date.

Long Strangle - This is similar to a long straddle, except the strike price of the call and put would be different.

Long Volatility - A strategy whereby one tries to capitalize on an increase in option implied volatility. The market position is ideally entered when option volatilities are at historical lows. One attempts to purchase those options that are most sensitive to an increase in implied volatility. Thus, long expiration dates are most sought after. An equal number of puts and calls are purchased which also roughly equates to delta neutrality. Of course, if one had a strong bias, bullish or bearish, then different strike prices would be chosen to reflect the anticipated price action.

Out-of-the-money (OTM) Call - The reverse of ITM call, being when a call option strike price is higher than the current market value of the currency price.

Out-of-the-money (OTM) Put - An put option whose strike price is lower than the current value of the currency price.

Premium - This refers to the payment or purchase price of an option. Premium is affected by volatility, interest rates, strike price, and expiration date. The premium can be quoted in a number of ways. In exchange contracts, they are usually quoted in points of currency, whereas in the otc market, vanilla options are usually quoted in percentage of currency and/or volatility terms.

Ratio Spread - This refers to an option combination where one holds a different amount of units of long options than short options. It is sometimes used as a hedge strategy. Example, you're long call options or underlying asset and the market begins to drop, you could sell two or more call options for each call option you own. In the case of being long the underlying, you could sell as many call options as necessary to achieve a negative delta.

Short Straddle - This is simply the opposite of a long straddle. Instead of buying an equal number of puts and calls, you would sell an equal quantity of both calls and puts with the same strike and expiration date.

Short Strangle - A market position which is constructed of a short call and short put in equal amounts with the same expiration date, but with different strike prices.

Synthetic Call Option - A position constructed by going long the underlying currency and long a put option. The risk/reward profile resembles that of a plain call option, thus the term "synthetic".

Synthetic Put Option - A position constructed with a short underlying currency and a long call option. Here too, the risk/reward profile is almost identical to a long put option.

Theta - The option sensitivity which refers to the time decay of options. Options lose value very slowly up until approximately 40 days or so, when the option begins to deteriorate at an increasing rate.

Vega - The sensitivity that refers to the volatility of an option. In general, the more time remaining until expiration, the more sensitive is the option to a change in underlying volatility.

Vertical Bear Spread - A market position that consists of long a put option and short another put option that is further out of the money, in the same month. This position results in a debit to your account and has a maximum loss and maximum profit as a profile.

Vertical Bull Spread - A market position similar to a bear spread, only that it is constructed with calls. Example, long call and short a call further out of the money in the same month. Risk is limited and profit is limited as well to the difference between the two strike prices.


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