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OTC Currency Options Explained.

OTC (Over the Counter) Currency options are defined as bilateral contracts, the value of which is derived from the value of some underlying asset or security. A Derivative covers any transaction where there is no movement of principle, and where the price performance of the derivative itself is driven by the price of the underlying asset.

It is especially this aspect (the no movement of principle) that makes Derivatives such useful instruments to hedge other exposures and to do specialized risk management.

Foreign exchange derivatives are the following: • Currency Options • Forex Futures • Swaps and Forwards

Foreign Exchange derivatives can be traded over the counter or on organized exchanges - On organized exchanges fixed and prescribed contracts are bought and sold. An OTC derivative instrument is tailored to customer's specifications regarding the specific dates, currencies and total amounts involved.

One of the main differences between exchange traded currency derivatives and OTC currency derivatives is the credit risk. In the OTC Market each party takes on the risk of the other party - On an exchange, the exchange's clearinghouse covers the parties' risk. In the OTC Market, because of the very specific contract details, liquidity may be very low, i.e. it may not be easy or possible to trade with such an instrument if the right party cannot be found.

A Currency option gives the holder the chance to fix the rate of exchange that will apply to a future exchange transaction. The Option writer (the seller of the option) must guarantee the rate chosen by the holder. For this guarantee a fee is charged. The holder of the option has all the rights implicit to the option but only one obligation - he must pay the fee.

The Option writer or seller has all the obligations, but no rights. In return for the fee he must have the underlying currency on hand (in stock) in case the holder chooses to exercise his option.

Currency Options can also be exercised at expiry or they can be sold back or sold on at any time during the duration of the transaction for fair value, which depends on the underlying currency price movements. Alternatively they can be physically delivered.

Currency Options is more flexible than a traditional forward outright foreign exchange transaction and gives the holder several alternatives:

• Whether, to exercise the option?
• When to exercise the option?
• How much to exercise?
• At what price to exercise?

This is a very simple and concise explanation of what is OTC Currency Options.

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Is it possible to obtain wealth from trading options?

Such as call and put options. Also does anyone know about forex trading? What tax benefits or pitfalls might one incur trading options?

Theoretically yes.

However MOST people accumulate wealth by investing. Trading options or forex is speculating, not investing. In other words, it is gambling. You can be well skilled and educated and still lose your behind very,very quickly.

Such trading is at the top of the risk charts, so yes, potential returns can be impressive but they come with a very sharp potential for a complete loss.

When you invest in stocks, bonds or mutual funds, you still have a risk of loss, but the odds of a total loss are slim, and you usually have time to get out before suffering a huge loss (unless you are also speculating with high volatility stocks).

Investing is not speculating. Investing combines an educated guess (no one really can guarantee a profit) with a moderation of risk. A lot of research shows that most investors do not do better by taking on higher than average risks. In other words, slower and steady wins the race.

As to tax issues. There are no benefits to short-term trading of any security. In fact all profits are taxed at your highest marginal rate. This is one more reason why trading rarely results in huge profits. By the time you subtract ticket charges and taxes you have to have a really big profit for you to end up with a better after tax return.

There are conservative strategies for options when combined with stocks you own. These strategies can add income to your portfolio without being significantly speculative.

People build genuine wealth by staying out of debt, by spending less than they earn, and by investing the difference wisely. If you start this as young as possible and routinely increase the amount you are saving and investing, you will build significant wealth.

However, just as with playing in Vegas, speculating is gambling and while a few walk away long term winners, it is ONLY a few that do win. In the short term, anyone can have a measure of luck, but in the long run, it is pretty rare.

The traders that survive on options and forex are big boys, with big wells of cash and years of training (and losing) behind them. They survive as much off the thrill as the wins.

But understand this, any wealthy trader is never playing with his full pot. He still has most of his assets in more secure investments. In fact, studies have shown that those that take the biggest risks with some of their money, have most their money in ultra-conservative investments. This is how they balance the high risk choices they make.

But if you're still determined, start reading, take a class and paper trade (trading simulation) for several months so you can establish techniques and indicators that work for you. Until you have both skill and discipline, you might as well just take a lighter to your money.

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