Exotic options and trading news events

Although forex is the largest and most liquid market in the world, during certain news announcements it can become extremely volatile, as dealers try to adjust to new information and millions of traders attempt to enter or exit the market at the same time.

Dealers often widen their spreads and trade execution can become problematic. Spot traders who are often trading highly leveraged positions expose themselves to tremendous slippage and potentially devastating losses if they are on the wrong side of the market. It is during this time that exotic options can be especially useful instruments.

The release of U.S. Non-Farm Payroll report at 8:30 a.m. ET on the first Friday of every month presents a notoriously difficult environment to trade — the EUR/USD will often rise or fall more than 100 points in a manner of seconds. While this can be a maddening time for spot traders, option traders can profit handsomely.

Because exotic forex options predetermine entry and exit points ahead of time, buyers of a one-touch option don’t need to worry about entering the market as liquidity suddenly disappears and many brokers widen their spreads to five times their usual size.

Nor do they need to worry about slippage on stops if their positions are wrong. They know if their analysis is correct and the currency pair trades through their price, they will profit; if they are wrong their risk is limited to the cost of premium.

The spot trader enjoys no such assurances. During these volatile times orders often slip hundreds of pips as dealers try to cope with order imbalances.

Furthermore, because volume often spikes to 10 times the normal level, simply accessing dealable quotes can be difficult. Some dealers provide phone access, while others only offer electronic order entry. Regardless of individual dealing practices, the process is rife with danger, especially for heavily leveraged traders. That’s why news events such as Non-Farm Payroll numbers, Central Bank rate announcements, current account reports, and inflation data can be traded with more flexibility and far better risk control using exotic options rather than spot.