Forex vs. options: what are the differences?
|Is forex riskier than options?|
|Is forex or options trading more profitable?|
|Capital needed to trade forex vs. options|
|Does trading forex or options take more time?|
|Learning time for options vs. forex|
When we explore the markets of foreign currency exchanges and options, we look at the driving factors that generate profit in each market. Forex is the buying and selling of foreign currency and is a multi-trillion-dollar industry. Options are a specific type of trading tool used when a trader is looking to obtain a financial asset, like a stock, at a specified price and date specified in the future.
However, despite the differences, both types of trading include premiums. This allows the financial institution offering the asset to benefit from buying and selling the asset to the trader.
Is forex riskier than options?
All markets carry some level of risk. However, both forex trading and options operate on the scale's riskier side. This is because if market prices are unsuitable for option holders, they will usually allow the option to expire as it isn't profitable.
Once this contract option fails to be activated by the purchaser, this is a risk management tool to ensure the loss isn't any more significant than the premium they originally paid to take out the option in the first instance. This works conversely, of course. If the option becomes profitable, the margin for gains increases more than a standard purchase of the asset in question.
Options are categorized into two separate types of contracts:
- Call Contracts - Whoever has bought this contract also has the option to purchase the asset which underpins it at an already specified cost at a later date.
- Put Contracts - This type of contract has the option to sell the underlying asset in the future. The future price is already agreed upon as part of the original contract.
With forex, the risk lies within the volatility of each currency. Due to huge investment banks and institutions causing the majority of the big swings, it can be more difficult to predict which way the market will go. The current economic uncertainty in the United Kingdom is an example of this, as traders have made serious profit trading against the weakness of the GBP (Great British Pound) compared to the USD (United States Dollar).
Forex's positives can also act as negatives. The market is 24/7, unlike stocks which operate solely during working office hours. The flexibility of forex due to the considerable amount of international pairings involved means that you can trade it any time of day. From this, the element of risk increases due to price swings that could theoretically occur anytime morning, noon or night.
Of course, you can alleviate any potential agitation from this non-stop form of trading by implementing automatic buy and sell tools on advanced mobile trading software such as the amana app.
However, your exposure to a market that operates 24 hours a day is completely different from the stock market with its fixed working schedule.
Whilst both have their positives, it is extremely important to be aware of the key risks involved in both forms of trading.
Is forex or options trading more profitable?
This is entirely dependent on the level of capital you are working with. Whilst both markets can return spectacular profits, they can also be extremely volatile. If we were to choose, we would say options are the more likely of the two to return a decent profit.
This is because you essentially set up the terms of your own purchasing agreement. So if you have an idea that the market or asset will move in a similar direction, you are essentially setting the terms for your investment.
As a general rule of thumb, if you are trading stocks, the highest leverage ratio you can obtain is 50:1. So, for example, if you buy a stock for $100, the maximum short sell is $5. Comparing this with options contracts, you will see the gigantic possibilities if a trade is executed correctly.
No leverage ceiling is factored into the trade, so theoretically, it's possible to use a leverage limit 10x the limit of stocks. This makes the possibility of options trading much more lucrative, but the added risk is intensified the higher the leverage you use. You can trade forex options but not to the same level, and the premiums are generally a lot higher, so profitability takes a bigger hit.
Capital needed to trade forex vs. options
Generally speaking, using your own capital for trade is the ideal way to begin. If you start with small amounts, you need to ensure you are trading smart to reduce the possibility of losses and enhance the return potential of your trades.
This applies to forex trading as well. Many beginners learn the hard way by suffering heavy losses whilst finding their feet. You can mitigate this by using demo software and automatic buy and sell limits whilst you find your feet in the market. This leads us to our next question.
Does trading forex or options take more time?
Historically speaking, forex trading would take more time than options as it would require examining the charts for volatility and analyzing a huge market that doesn't close. With options, you can agree to your terms and wait to see whether or not it hits the price. If you have opened the position initially, you wouldn't have to be glued to a chart like with forex.
However, thanks to modern advances in coding, you can automatically set up buy and sell orders on mobile trading apps such as amana, so neither forex nor options trading takes up considerable chunks of your time.
Learning time for options vs. forex
Allowing yourself time to effectively understand both markets is essential if you're looking to put your capital at risk. It is sensible and highly advisable to read up on both tutorials and definitions to ensure you understand the risks involved.
This isn't exclusive to forex vs options either. This applies to all types of trading, and ensuring you fully understand the market is the first step to becoming a successful trader with sensible trading psychology.
We hope you now have a much better idea about the differences between forex vs. options trading. If you would like to read more about options, head over to our Options, stock & ETF trading software blog.