Financial markets, in general, are very fascinating and promising, especially in the eyes of risk takers as you. In the markets you can find out some derivative products such as futures, swap and option. And foreign exchange market also provides such derivatives. One of the booming products is forex option trading. Nevertheless, before you left your head and heart on the forex option trading floor, you ought to know the difference between forex spot, or cash, trading and forex option trading.
Forex spot trading is where a currency is exchanged with another currency. Forex spot trading allows you to trade two different currencies simultaneously, hence when you buy a certain currency, then at the same time you sell another certain currency. Hence the term of currency pair made.
For example when you buy AUD/USD, it means you purchase Australian dollar and at the same time you sell US dollar. In forex spot trading, the price or value of a currency what you see now is what you will get. When you see AUD/USD at 1.0255 and you take it as your buy position, in order you can gain some profits, you have to see the AUD/USD rises above 1.0255. If the pair drops then you have to take some of your money out of your wallet to pay for the loss.
Meanwhile, in forex option trading, you don’t actually buy a certain currency. Using the same example, when you buy a call option, it means you purchase a right, but not an obligation, to buy AUD/USD at a certain price in a specific time frame. Say today AUD/USD is at 1.2000 then you foresee AUD/USD will go north to 1.3000 in two weeks from now then you can buy call option at that price. In this case 1.3000 is called strike price and the two weeks or 14 days is called expiration date.
Now you can clearly see that even present price of AUD/USD is 1.2000, you can buy it with certain premium price, say USD 10, at the price of 1.3000. When AUD/USD eventually goes north as you predict in the agreed-upon time frame then you’ll bring home your profit. But if AUD/USD eventually goes south until the expiration date of the option, then you have to pay the loss. How much is your loss? Only the premium, it is only USD 10.
Now as you have brighter view on the difference between forex option trading and forex spot trading, you can consider diversifying your investment portfolios. Always remember, don’t put your eggs in one basket.