Trading Contract In Forex And Trading Currency Pair Directly – A Comparison
The World Currency Options traded at the NASDAQ exchange are an alternate mechanism for trading contract in FOREX currency pairs. This article looks at some of the broad pros and cons of trading these contract options as opposed to trading the currency pairs directly in the FOREX market.
Many people have asked us what is a better trade: Trading Contract in FOREX pairs or Trading Currency pair directly in the FOREX market. The answer is not really a straightforward one – it is a little more complicated (as with all things, right?). But it is not too complicated either and very much depends on what a trader is looking to do.
First of all, we think it is important to introduce the concept of Trading Contract in FOREX pairs. The Philadelphia exchange (which has now merged with the NASDAQ) allows trading contract options in 10 FOREX pairs. These are all US Dollar settled contracts and can now be traded through most brokerages. This is yet another way to trade the underlying currencies and provides an option to the currency trader.
Now that we have introduced the concept of trading contract in FOREX pairs, let us look at some of the advantages and disadvantages of using this trading method.
The first disadvantage for true FOREX traders is that there are only 10 FOREX pairs on which one can trade options. And all of these are against the US Dollar (USD). The 10 currency pairs are:
XDE – Euro against the USD
XDS – Swiss Franc against the USD
XDA – Australian Dollar against the USD
XDC – Canadian Dollar against the USD
XDN – Japanese Yen against the USD
XDB – British Pound against the USD
XEH – Swedish Krona against the USD
XEV – South African Rand against the USD
XDM – Mexican Peso against the USD
XDZ – New Zealand Dollar against the USD
So, if a trader wants to trade other currencies or cross-currencies (such as British Pound against the Euro) they cannot trade the contract options.
Also, as one may expect, the volumes are much lower than what one may find in the direct FOREX markets. Of course, as more and more traders get familiar with these instruments, the volume will keep going up. But it will probably still not reach the levels of the FOREX market.
Another disadvantage in comparison to the FOREX market is that the trading is restricted to the NASDAQ trading timings. The FOREX market is a 24-hour market. The disadvantage is that there may be huge moves in the currencies during the night, which a trader cannot trade. The trader in the contract option has to wait for the stock market to open.
So, we are listing so many disadvantages. Are there any advantages at all? Yes. The biggest advantage is risk management. There is some level of insulation from the potential gyrations of the FOREX market as the movements of the contract option are more manageable. Also, the risk is limited to the premium paid for the contract option.
The other big advantage is that trading contracts allows one to trade other strategies such as straddles, strangles, etc. that allow for better hedging. The FOREX market (at least the US brokerages) does not allow a trader to go long and short the same currency pair at the same time. With options a trader can execute such long-short strategies. Why would any trader want to do that? Trust us, there are several benefits to such trades.
But that will be the topic for another article.
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ABOUT THE AUTHOR
Indranil Sengupta has been an investor and trader in stocks, options and FOREX for over 20 years. He has strong experience in technology sector and global markets. He is an editor with TalkFN.com where he discusses trading strategies, real-world trades and trade results. For more on this topic, please go to Trading Contract in FOREX.