Factors in Option Trading Costs
Forex Options have no definite price. Understanding the factors that affect this is essential for any trader that wants to conquer the field of Forex Options trading.
In pricing the options, there are several factors to consider to appropriately determine its value. Learning this is essential to understand how an option works.
- Volatility – Volatility is the measure of uncertainty or risk with regards to the size of change in an option’s value. Higher volatility means increased chances of hitting the strike price within the limited time period. This is why as the currencies get more volatile, the higher the options premiums are.
- Time Value – This is the length of time where the strike price can occur where pricing is uncertain. Naturally, the longer the time value is, the chances of hitting the strike price is increased that is why premiums are higher.
- Interest Rate Differential – The relationship between the strike price and the current market rate is significantly affected by the changes in interest rates that’s why it is included in the computation of the premium price as a function of the time value.
- Intrinsic Value – The intrinsic value is the options price currently without the time value. It is used as basis to determine a strike price that can be one of the following:
- “In the money” – the current price is lower than the strike price.
- “Out of the money” – the current price is higher than the strike price
- “At the money” – the current price is the same value as the strike price