What are the Types of Risks in Forex Option Trading?
Just as any other transaction in any type of financial market trading, the investor will always be facing risks. In the currency trading transaction involving forex options, some types of risks are to be expected. The main risk in options trading, just like with any other securities trading, is the value of the option changing over a period of time. The risks in forex options are even more complicated to predict and understand than that of the risks in securities trading. The beauty of the said risk is that it can be quantified and estimated. This can be done by using the hedge parameters of the option as well as the expected changes in the inputs of some models. To do the mentioned calculations, some technical valuation models have to be used such as the Black-Scholes and Ito’s lemma.
Two types of risks are involved in forex options trading, the pin risk and the counterparty risk. The first one is a special situation that happens only when underlier will close at/very close at the strike price of the option on the last day it was traded before the expiry date. This puts the seller in a situation wherein he is not sure if the option will be taken or allowed to expire. This would have the seller end up with an unwanted large residual position the day the market opens after expiry date.
The counterparty risk, although seldom happens and is generally ignored, involves the situation wherein the seller will refuse to buy or sell the assets agreed upon on the option contract. This risk may not happen at all if the trader makes use of intermediaries known to have strong financial capabilities. Only a major crash or widespread panic may bring about such situations.
