V.8:1 (33-36): Successfully trading currency options by Thomas J. Dorsey

Successfully trading currency options by Thomas J. Dorsey

Many people equate the options market with gambling in a Las Vegas casino. Many investors do experience losses trading options, but their losses are usually due to both an abuse of leverage and little understanding of the role that the underlying currency plays in the equation. To make money trading currency options, you first must be successful trading the underlying currency. Reversing this order will surely lead to financial disaster.

Comparing currency trading to gambling in Las Vegas is the same as comparing speculation to gambling. Although both carry a degree of risk, speculating is generally perceived as a calculated risk while gambling is a game of chance. A speculator in the options market has the ability to adjust the risk-reward characteristics of a trade. A gambler simply accepts the odds attached to a game of chance. The first concept an option trader must understand is probability. Webster defines mathematic probability as "a number expressing the likelihood of occurrences of a specific event, such as the ratio of the number of experimental results that would produce the event to the total number of experimental results considered possible." The probability of getting heads or tails when flipping a coin is 50-50. Each event is independent of the other.

The probabilities of trading in currencies are not as black and white as flipping a coin or rolling dice. There are many more variables that must be considered, but in the end it is the irrefutable law of supply and demand that causes a currency to move. If demand for a particular currency increases while supply remains the same, the currency price must rise. If supply increases while demand remains the same, the currency price must go down. If demand and supply are even, the currency will remain unchanged.