Benefits of Buying Options: Limited loss, Unlimited Profit Potential on Long Call Positions

Have you ever bought a forex trade and forget to set a stop-loss only to find out later the price plummeted and you received a margin call on your account? One of the benefits of buy call options are the possibilities for unlimited profit with limited loss. Unlike with the underlying asset, the call option’s loss is limited to the premium paid, but the option has no maximum price cap. So if you bought an option and minutes later the market releases huge news driving the price of the currency you bought up, you are in luck! Big market moves tend to happen around big news events like the Non-Farm Payroll (NFP).

To trade an upward market trend (uptrend), you can either go long (through buying) in the underlying market or buy a Call option. The charts below shows you the difference between the two trades.





If the market rises, both the buy trade in the underlying and the Call option will bring a profit, and if the market falls, both will bring a loss. However, the Call option will never get stopped-out and loss is limited to the premium paid at open.

Let's say, you expect the price to rise. Therefore, you buy a EUR/USD spot at 1.1900 on Day 8. This is indicated by the green dotted lines on the chart below. Simultaneously, protecting your maximum loss if the price were to fall by placing a stop-loss order at 1.1800. On day 15, the market suddenly falls due to unexpected market news. By day 16, the price of EUR/USD passes your stop-loss at 1.1800. This is indicated by the red dotted lines on the chart below. Your stop-loss automatically closes your trade preventing further loss to your account's balance as the market falls below 1.1800. 

Timeline of Paragraph Above

Day 8 (EURUSD trade opened) – 1.1900 (with a stop loss of 1.1800)
Day 15 market starts to falls
Day 16 – EURUSD passes your stop-loss order of 1.1800 and your trade is automatically closed.

Alternatively, you opened a long (buy) call option with a 21-day expiry from Day 0 because you expect the price to rise. In this scenario, you can watch the market fall below 1.1800 and not worry about being stopped-out because you have the right, but the obligation to exercise your option. Note that the option trade is still open and active if not exercised before expiry, and if the EURUSD trends upward again you still have the option to exercise if the payout does become profitable. 

But say you decided not to exercise the option on Day 10 because you thought the market was rising. Because the option is still open on Day 18 when the market rises again on positive news and goes to 1.2020, you still have the right to exercise the option and receive a good payout (see graph above and payout table at the end of this lesson).

Timeline of Option Paragraphs Above

Day 0 (EURUSD long call option opened) – strike 1.17832
Day 10 - Market high, but you decide not exercise your option yet
Day 16 – Market low, you are still holding your option
Day 18 to 21– Market rises on positive news and option is profitable upon execution.
 

Execution at Day 10

If you had decided to either sell the underlying asset or exercise the option at Day 10, you would have made at profit. Here is how to calculate your profit for both the underlying asset and option, assuming previously stated parameters for the EURUSD spot (e.g., buying at 1.1900) and the EURUSD long call option:

If you sell the 100,000 EURUSD at 1.202, you have a profit of 1,020 USD.
(fx=(1.202-1.190)*100,000)

If you exercise the 21-day long call option for 100,000 EUR at 1.17832 for 1,173 USD, at 1.20177, your premium/payout at expiry would be double the amount of premium you invested, $1,173. Add the premium at open -1,173 USD to premium/payout at expiry 2,345 USD in the chart below to calculate your profit or loss.
(fx=( -$1,173 + $2,345 = $1,173))

Please note that the strike rates are not the same for the spot and option in the examples above.