John Jagerson

Trading Where You Think Prices Won't Go

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Our case study will be on the GBP/USD during the decline in January-February 2008. The market had retraced to resistance on 1/30 (point A.)

Forex traders would normally evaluate a short spot trade to take advantage of a move to the downside, but writing an option may be more attractive and provide a little more room for a volatile market. In this case, assume that a call was sold with a strike price 130 pips above the close price on 1/30 at 2.0000.

It may sound a little unexpected to sell a call if you are bearish, but remember that now you are an options seller, not an options buyer, so things are reversed. You want the market to fall so that the call you sold will fall in value or expire worthless. If you were bullish and wanted to sell an option, you would sell a put because you want the market to rise and that put to fall in value.

In the case study, assume that you sold a call with about 2 and a half weeks until expiration on Feb. 15, 2008, and that call is worth $145 for a $10,000 lot. That is the equivalent of 145 pips.

What you want in this trade is for the exchange rate to stay below your strike price until expiration. In the image you can see two dotted line barriers that outline where you want prices to stay and within what time frame.