The Calm Before the Storm..
The markets are stable this morning ahead of the highly anticipated US Non-Farm Payroll (NFP) announcement at 12:30 GMT. The figure reveals change in US employment (apart from the farming industry) for the previous month. It is regarded as an important economic indicator, where a highly positive figure is a sign of growth and a negative figure is a sign of contraction. Today's result is expected to show that 225,000 jobs were added in July.
If the result comes as expected or better we may see USD strengthen as the market take this as a sign the Fed will increase US interest rate sooner rather than later. If the result is less than expected we may see USD weaken. Either way we can be confident that volatility in either direction will be high as the figure is released.
Buying options may be a useful way to trade over volatile periods because it is a trade with limited risk and you cannot get stopped-out. It allows you to wear a move against you without exposing you to larger risk and as long as your view on direction is correct before the options expiry you may profit.
There are two types of options; a Call and a Put. You would buy a Call if you expect a price to rise because a Call gives you the right to buy at a certain price over a certain period of time. You would buy a Put if you expect a price to fall because a Put gives you the right to sell at a certain price over a certain period of time.
The following gives three possible examples to trade GBP/USD over the next week.
Trade 1 - Uptrend on limited risk
Buy a Call option to reserve the right to buy 10,000 GBP at the current market rate (1.5525) over the next week. On the trade ticket below you can see the strike is the reserved rate and the amount is the contract size. The total risk when entering this position is the cost to buy the option, that is 75.11 USD.
If GBP/USD rises above 1.5525 strike over the next week the option may return a profit. If the pair does not rise a loss is made but this loss is limited to the cost of the option and you cannot get stopped-out by volatility.
Trade 2 - Downtrend on limited risk
Buy a Put option to reserve the right to sell 10,000 GBP at the current market rate (1.5520) over the next week. The trade ticket below shows this trade and it costs 74.57 USD to buy. This is the opposite position to buying a Call option; instead you benefit as GBP/USD price falls.
If GBP/USD falls below 1.5520 strike over the next week the option may return a profit. If the pair does not fall a loss is made but this loss is limited to the cost of the option and you cannot get stopped-out by volatility.
Trade 3 - Increase in volatility regardless of direction
If you believe GBP/USD will move significantly either up or down, hence you want to trade an increase in volatility but have no view on direction, you may buy a straddle strategy. This involves buying a Call and a Put, with the same strike and expiry, at the same time.
The image below shows this strategy set-up in the Advanced mode on the optionsReasy Web-Platform. The Advanced mode allows you to buy more than one option at the same time. In this example we are buying a Call and a Put with strike 1.5520, expiry 7-days for contract size 10,000.
You can see it costs a total of 98.50 GBP (152.87 USD) to buy this position. This is your total investment size and maximum risk. If GBP/USD rises by over 152 points in the next week the Call option leg will return more than 152 USD payout and if GBP/USD falls by over 152 points the Put option leg will return more than 152 USD payout. Either way, up or down you will receive a profit. If GBP/USD expires within the range 1.5368 - 1.5672 the position will make a limited loss.