Torpedo Betty Blog
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Option Trades
November 7th, 2009 by admin
In placing an option trade, the center of attention for the forex trader is on where the spot forex price is. The spot price is called the at-the-money strike price. Whenever a call or put option is purchased, the strike price is either in the money (ITM), at the money (ATM), or out of the money (OTM). Options can also be deep in the money and deep out of the money. The term moneyness refers to this relationship of the option price to the at-the-money price.A vast body of financial mathematics and expertise has developed to constantly improve the algorithms that generate a fair price of an option.
The most famous of all of the mathematics of option pricing has been the Black-Scholes equation. The Nobel Prize was awarded for developing the mathematics behind this equation. It forms the basis for the market to fairly price an option because the equation showed what a fair value would be for a premium on an option. But the equation assumes constant volatility. Black-Sholes was not developed for forex markets where there is no constant volatility. The world of forex options is not a Black-Scholes world, and for the average trader, this means he or she must be even more cognizant of the probability that during the option trade period, changes will occur in the market environment that cannot be fairly reflected in the premium prices. The forex option trader has a paramount need during the option trade to allow enough time to be right but not enough time for too many changes in the real-world environment.