Trading on margin is a vital part of any day trading strategy and many want to know whether they should consider forex vs options trading.
Forex traders bet on the rise and fall of international currencies, while options traders tend to focus on stocks or commodities.
When it comes to forex vs options trading, the forex market has its benefits with 24-hour trading, good liquidity, execution speeds, and low commissions. However, options can deliver higher percentage returns, limited downside, and can also offer several strategic alternatives where traders can also combine them with other assets.
With well over thirty years of options trading experience, I’ll expand on why I believe options are a better trading strategy than forex.
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Is Forex Riskier than Options?
Forex and options trading each have their own risks, but if you learn enough about options trading, then I believe forex is the riskier strategy.
Risks with Options Trading
When buying put or call options, you pay a premium and that is your defined risk. Importantly, this limits risk. This is also valuable when setting a trading strategy and it can help to remove the emotions from losing positions.
Regarding options trading risk, it’s important to note, however, that after getting set up as a trader, newcomers are excited to buy options when they discover the cost of options are a fraction of the costs of stocks. Once they learn how to trade options, they realize that buying options can be a risky strategy due to time decay.
On the other hand, selling options naked can give traders unlimited risk.
Selling puts and calls allow traders to take advantage of option time decay, however. For this reason, my work is based primarily on using options spreads that allow traders to sell options for income while also managing the downside risk with more advanced option strategies, such as option butterfly spreads.
Options trading also has an advantage over forex in that you are always planning an exit strategy ahead of time when you trade options due to option expirations.
Risks with Forex Trading
Forex trading allows you to set stop losses, but in volatile markets, a stop loss can suffer from slippage. Plus, you always can lose more than you planned with stop losses.
The Swiss Franc devaluation in 2015 was a prime example, where the Swiss central bank re-valued the Franc against the euro in a shock announcement. That wiped out many trading accounts, but also many forex brokers.
Is Forex or Options Trading More Profitable?
We can see options as more profitable for the reasons noted previously. If you can protect your downside, then the profits will be larger. Financial regulators have clamped down on leverage in the forex market, but that also limits upside potential.
In options trading, simply understanding and capitalizing on the pricing mechanism can lead to large profits.
Options are cheaper to buy when the market expects low volatility. If the market then moves quickly beyond the standard deviations (volatility expectations), the options will market will react and re-price them higher quickly, while market re-positioning will create demand and a short squeeze effect.
If this happens with a surprise earnings announcement in a stock, for example, then the profits can be big.
Which is Easier: Forex or Options?
Forex is easier to trade vs options because traders simply have to buy or sell and then manage Forex trades. That can be done with limited orders and is easy to learn. Options traders have to learn the difference between buying and selling puts and calls. They also have to understand the pricing of options and the dynamics of implied volatility and delta.
A forex trader in the spot market will only have to buy and hold with a particular target in mind. Options traders have to select the actual price target and match it with a timeframe, which brings time value into the equation.
The ease of Forex trading also has a detriment, however. The simplicity of Forex trading lends itself to over-trading because the buying and selling process is so cheap and easy.
Capital Needed to Trade Forex vs Options
Forex traders need more capital to trade than options traders do, but that can vary based on the broker. Some forex brokers will allow you to open an account with less than $1,000 and trade on 20-30x leverage.
Although this may like a good deal, there are no shortcuts to making money. Many new traders will blow up multiple forex accounts because they do not apply proper risk management strategies.
Having a limited downside to options ensures you can protect your capital.
Does Trading Forex or Options Take More Time?
Trading options takes about the same time as trading Forex for traders who buy and sell options outright, or naked. When trading option spreads, it takes more time to trade options than Forex, however, since one overall trade has two to four legs.
Writing covered calls requires less time than option spreads since there are only two legs, but covered calls have very little downside risk protection. Since covered calls are better suited for stock investors vs traders, we cannot really compare them to Forex trading.
Learning Time for Options Vs Forex
Learning to trade forex and options can be a quick process, but mastering options takes a lot longer. Options traders will take more time to explore the intricacies of the product because there are many strategies available.
Options Trading Is More Versatile Than Forex Trading
We can use options in conjunction with a stock to protect the downside risk if the stock owner feels the market is high, or if there is an event risk, such as earnings. Investors can even predict stock prices with options data.
Options traders can also trade on the long and short side of an asset, or set different strike prices on the upside and downside ahead of potential volatility.
Learning about options pricing will also open up more profit opportunities and strategies such as How to Take Advantage of an IV Crush.
Forex Vs Options in Volatile Markets
Options provide multiple strategies to profit during quiet market periods. During times of high volatility, however, options trading can cause higher profits because of the higher option premiums option sellers get.
One of the big problems with forex is the slippage in volatile markets and the tendency to over-trade.
Are There Forex Options?
Yes, you can trade forex options with any broker that offers access. The most liquid market is the CME Globlex exchange and forex options can be beneficial for short-term trading because they allow you to set a daily expiry.
Forex options track the underlying currency pair and can settle in cash or spot.
Forex Vs Options Liquidity
The Forex markets are often the most liquid markets that exist. For example, when trading pairs such as the Eur/U.S.D. cross, you’re trading one of the most liquid markets in the world. The reality is that highly liquid markets are easier to trade than less liquid markets. There are always buyers and sellers resulting in narrow spreads.
Many option contracts have very low volume, but option traders can work around this problem by trading only highly liquid options; there are plenty of them.
Forex and Options Trading
It’s important to address that trading forex vs options is not either, or decision; Forex traders can trade Forex options. In other words, Forex is the underlying asset for the option trades.
Those who have a keen interest in Forex trading can add options to their Skillset after they get comfortable with options trading. Some Forex traders, however, choose to protect their positions with puts to manage risk early on.
Forex Vs Options Trading
|Risk||Stop Losses Mitigate||Spreads Control Risk|
|Profits||Subject to Higher Losses||Better Risk Management Increases Profits|
|Ease||Easy to Trade||Options Are More Complex|
|Capital||Varies Based on Broker||Varies Based on Broker|
|Time to Learn||Faster to Learn||More Time to Learn|
|Time to Trade||Same as Naked Options||Spreads Take More Time|
|Liquidity||Highly Liquid||Less Liquid|
Trading forex or options is a decision that many traders consider, but in my experience, it is worth putting in the extra work to learn how to trade options.
While there are both pros and cons of options trading, the limited downside with spreads and the ability to generate more consistent income from selling options safely are the key selling points for options.
Mastering the pricing dynamics of options will put the odds firmly in your favor.