Bull Currency Spreads

For some traders, retail spot currency trading has gained popularity as a manner to try to generate income and profit from the constant variations in price levels of international currencies. Sudden or severe market movements, however, can create risks, particularly for retail traders who may not have the technical information or financial resources that are available to larger institutions in the market.

Spot traders, for example, must be agile at timing entrance or exits in the market and accurate in setting stops in order to avoid losses. These risks are compounded by high leverage now available to traders that can multiply the potential for profits or loss, depending on the outcome.

A variety of strategies have evolved in the options market, such as "straddles," "strangles," "butterflies" and "condors." These may help traders boost profits and hedge against losses, or both depending on the expected direction and intensity of price movements. These strategies typically involve the simultaneous purchase of more than one options contract (a call or a put) to offset the risks of unexpected price movements and the transaction costs associated with options trading, known as "premiums."

What Is A Bull Currency Spread?

A bull currency spread is a popular trading strategy among some traders. It can be carried out in one of two ways, using either call options or put options. With call options, the bull spread strategy is carried out by buying a call option (the long leg) for a particular currency and selling a call option (the short leg) for the same currency and expiration at a higher exercise price. Similarly, with put options, the spread strategy is again carried out by buying a put option for a currency at a lower exercise price and selling a put option for the same currency and expiration at a higher exercise price.

The bull currency spread is commonly used when traders expect that a currency will appreciate moderately, but not by a lot. With the bull currency spread, a trader opts to limit the upside potential for profit in exchange for reducing the cost of taking a position. If the currency appreciates to the full value of the higher exercise price, the trader can take the maximum gain. By establishing an upper and lower limit, the trader faces an "opportunity cost" of not taking the still higher upside gains that could be made with a "naked" option.

However, the execution of a bull call spread will be charged a net premium, while a bull put spread will earn a net premium. This is because premiums paid on options transactions are higher when closer to the spot price. In either case, the premiums of the long and short legs of the bull spread will at least partially offset one another, thus reducing the cost of taking the position in a currency.^[2]

As an example of a possible trade, a trader may consider establishing a bull call spread in Canadian dollars at exercise, or strike, prices of US$.84 and US$.85 with premiums of US$.014 and US$.018, respectively. If the Canadian dollar moves to US$.845 before or at the expiration, the trader can exercise the contracts to post a small gain. The result will be US$.845 (higher call strike price) - US$.84 (lower call strike price) - US$.018 (premium paid for buying higher-priced call) + US$.014 (premium received for selling lower-priced call) for a net gain of US$.001 per currency unit. For a contract with a lot size of 100,000 units, the trade would be worth US$.001 x 100,000 = US$100.

If the currency moved to US$.90, the gain would be US$.90 (higher call strike price) - US$.84 (lower call strike price) - US$.018 (premium paid for buying higher-priced call) + US$.85 (proceeds from lower call) - US$.90 (cost of higher call) + US$.014 (premium received for selling lower-priced call) for a net of US$.006 per currency unit. For a contract with a lot size of 100,000 units, the trade would be worth US$.006 x 100,000 = US$600. While this trade makes a greater profit, the gain is limited to US$.006 for any future spot price above US$.85.

However, there are still situations in which a trade may lose money. If the Canadian dollar only moves to US$.843, the result would be US$.843 (higher call exercise price) - US$.84 (lower call strike price) - US$.018 (premium paid for buying higher-priced call) + US$.014 (premium received for selling lower-priced call) for a net loss of US$.001 per currency unit. For a contract with a lot size of 100,000 units, the trade would cost US$.001 x 100,000 = US$100.^[3]

In the U.S., currency options contracts are commonly traded at the Philadelphia Stock exchange, the Chicago Mercantile Exchange and at online exchanges. In Europe, they can be traded on the Eurex Exchange. Some exchanges offer "one-leg contracts" and same-day expirations to simplify the process of making trade orders.^[4]

Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.