Why are currency pair quotations flipping from option levels
Option levels are seen by Forex traders as lines of resistance and support, so are applied in the countertrend strategy of trading currency pairs. Such ideology arose due to the peculiarities of contracts.
A naked option buyer who does not have a position in the underlying asset makes a profit:
From increasing the Call premium as the course is raised and removed from the strike on which the option is purchased;
From the increase in Put 's premium as the rate falls below the strike of buying a contract;
If the forecast is incorrect, the Buyer will only lose the option premium paid. In contrast, the Option Seller risks an unlimited loss, and the profit in the form of the premium paid by the Buyer will remain with it only in case of "combustion" of the option "out of money," i.e. the rate at the time of expropriation should be:
Above the Put level of the option sold;
Below is the Call strike on which the contract was sold.
Therefore, the trader, in most cases, will observe a picture of the remote maximum Open Interest Put and Call from the current quotation values at the time of the start of the contract term. Sellers will not without a special reason issue a large number of contracts at the prices of the first day of bidding. The maximum OI will be roughly "at the edges" of the volatility of a week, month or quarter.
Traders who bought Put and Call options much lower and higher than the current exchange rate of the currency pair (and such, judging by the Open Interest, most) purchased them at a low cost, which will increase at times when and if the strike equals the price.
But even if this condition is met, there may be no profit: over time, the option premium has the property of aiming to zero as the expiratory deadline approaches. Therefore, as soon as the currency pair approaches the strike, the fixation of the profite begins.
It differs from the currency and stock exchange markets, as you can 't put a teak profit on an option because contract premium pricing depends on many of the parameters described by the complex Black-Scholes formula. You can fix a premium instantly by selling an equal number of futures against the Call option or buying against Put contracts.
The higher the open interest of the strike, the more futures will be sold or bought against the fall or appreciation of the currency pair. In theory, as the price increases or decreases, one can expect a gross increase in countertrend transactions equal to the volume of OI crossed by strike quotations.
Thus, the size of the Open Lead determines the probability of trend reversal and the strength of the level:
Resistance - by number of open Call contracts;
Support - on the open interest of Put contracts.
The paper gives a simple example of the operation of the mechanism causing the reversal, in practice option strategies are a complex design of purchased and sold contracts of different types related to currency spot and futures. In any case, the price movement causes a reorganization of the so-called exposition, which can lead to a reversal of quotations.
Traders use monthly and weekly options to find reversal points (Friday). The former give the most significant levels of quotation rollback, the latter guarantee this movement with less probability.