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Binary Forex Options and Alternatives

I generally don't consider myself a forex degenerate. Staying up all night on a stream of coffee and cigarettes staring at central bank manipulations is just not my thing -- at least not yet.

But I do tend to have intermarket theses, and I would like to use options to structure risk around my thesis every once in a while. Of course you can trade currency futures or the FX crosses, but I tend to have an edge in the options market. But what trading vehicles are available?

Well, there's really not much out there from a liquidity standpoint, so it doesn't make sense to be scalping forex options. Instead, I would go with trading around spreads that have a fixed risk so you can "set it and forget it."

The first set you can consider comes from the ISE:

And that's a nice list. The problem is, they don't offer good options liquidity. The spreads on EUI are .07-.08 wide, and there's very little volume or open interest.

There's been some innovation in the forex space with respect to binary options, also known as fixed return options. These are essentially a product that is structured so if a condition is met (touching or closing) then you will receive a payout of $100. The cost of the contract is derived from option pricing models and set by the market. I'm definitely intrigued at this kind of instrument, but you often have to deal with the shady underbelly of the forex world to get this sort of access.

The best trade option out there is dealing with Currencyshares etfs.

The liquidity isn't the best, but you actually have people trading these, and the spreads aren't that bad either.

And it comes back to binary options. You can structure your own binary option by way of a vertical spread. That is where you buy an option and sell an option, with the variation in the strike price. It is limited risk, limited reward, and it models FROs very well except for the difference in the hysteresis.

So before I start staying up with my Keurig and Marlboros all night scalping pips on the cable, I'll start with these first.

Are there any other areas that I've not yet covered in this? Let me know in the comments section.

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/