Forex Hedge:

A forex hedge is a transaction implemented to protect an existing or anticipated position from an

unwanted move in exchange rates. Forex hedges are used by a broad range of market participants,
including investors, traders and businesses. By using a forex hedge properly, an individual who is long
a foreign currency pair or expecting to be in the future via a transaction can be protected from
downside risk. Alternatively, a trader or investor who is short a foreign currency pair can protect
against upside risk using a forex hedge.

Understanding Forex Hedge :

It is important to remember that a hedge is not a money making strategy. A forex hedge is meant to
protect from losses, not to make a profit. Moreover, most hedges are intended to remove a portion of
the exposure risk rather than all of it, as there are costs to hedging that can outweigh the benefits after a
certain point.

So, if a Japanese company is expecting to sell equipment in U.S. dollars, for example, it may protect a
portion of the transaction by taking out a currency option that will profit if the Japanese yen increases
in value against the dollar. If the transaction takes place unprotected and the dollar strengthens or stays
stable against the yen, then the company is only out the cost of the option. If the dollar weakens, the
profit from the currency option can offset some of the losses realized when repatriating the funds
received from the sale.

Using a Forex Hedge

The primary methods of hedging currency trades are spot contracts, foreign currency options and
currency futures. Spot contracts are the run-of-the-mill trades made by retail forex traders. Because
spot contracts have a very short-term delivery date (two days), they are not the most effective currency
hedging vehicle. In fact, regular spot contracts are often why a hedge is needed.

Foreign currency options are one of the most popular methods of currency hedging. As with options on
other types of securities, foreign currency options give the purchaser the right, but not the obligation,
to buy or sell the currency pair at a particular exchange rate at some time in the future. Regular options
strategies can be employed, such as long straddles, long strangles, and bull or bear spreads, to limit the
loss potential of a given trade.

Example of a Forex Hedge

For example, if a U.S. investment bank was scheduled to repatriate some profits earned in Europe it
could hedge some of the expected profits through an option. Because the scheduled transaction would
be to sell euro and buy U.S. dollars, the investment bank would buy a put option to sell euro. By
buying the put option the company would be locking in an 'at-worst' rate for its upcoming transaction,
which would be the strike price. As in the Japanese company example, if the currency is above the
strike price at expiry then the company would not exercise the option and simply do the transaction in
the open market. The cost of the hedge is the cost of the put option.

Not all retail forex brokers allow for hedging within their platforms. Be sure to research the broker you
use before beginning to trade.

What is Forex Arbitrage :

Forex arbitrage is the simultaneous purchase and sale of currency in two different markets. Arbitrage
in itself is a trade that profits by exploiting the price differences of identical or similar financial
instruments on different markets or in various forms. So, with forex arbitrage, foreign exchange traders
acquire currency pairs to exploit any short-term pricing inefficiency between them. However, prices
tend to move toward equilibrium across markets, so it may be difficult to find such price discrepancies.

Forex arbitrage can occur, for example, when a trader at one bank offers to sell a currency at a lower
price than a trader at another bank is offering to buy it. A forex arbitrage trade profits by
simultaneously purchasing the currency from the one seller, and selling it to the buyer. However, there
is the hazard of execution risk if the price should change or re-quote, which could reduce the profit or
generate a loss.

Electronic trading, which is high-frequency trading using algorithms and dedicated computer
networks, has shortened the timeframe for forex arbitrage trades. Previously, price discrepancies would
last several seconds. Now they may remain for only a second or less, before reaching equilibrium.
However, volatile markets and price quote errors or staleness can still provide arbitrage opportunities.

Other forex arbitrage includes:

 Currency arbitrage involves the exploitation of the differences in quotes rather than movements
in the exchange rates of the currencies in the currency pair.
 A cross-currency transaction is one that consists of a pair of currencies traded in forex that does
not include the U.S. dollar. Ordinary cross currency rates involve the Japanese yen. Arbitrage
seeks to exploit pricing between the currency pairs, or the cross rates of different currency
pairs.
 In covered interest rate arbitrages the practice of using favorable interest rate differentials to
invest in a higher-yielding currency, and hedging the exchange risk through a forward currency
contract.
 An uncovered interest rate arbitrage involves changing a domestic currency which carries a
lower interest rate to a foreign currency that offers a higher rate of interest on deposits.
  Spot-future arbitrage involves taking positions in the same currency in the spot and futures
markets. For example, a trader would buy currency on the spot market and sell the same
currency in the futures market if there is a beneficial pricing discrepancy.

Forex Arbitrage Challenges :

Some circumstances can hinder or prevent arbitrage. A discount or premium may result from currency
market liquidity differences, which is not a price anomaly or arbitrage opportunity, making it more
challenging to execute trades to close a position. Arbitrage demands rapid execution, so a slow trading
platform or trade entry delays can limit opportunity. Time sensitivity and complex trading calculations
require real-time management solutions to control operations and performance. This need has resulted
in the use of automated trading software to scan the markets for price differences to execute forex
arbitrage.

Forex arbitrage often requires lending or borrowing at near to risk-free rates, which generally are
available only at large financial institutions. The cost of funds may limit traders at smaller banks or
brokerages. Spreads, as well as trading and margin cost overhead, are additional risk factors.

Currency Arbitrage

What is Currency Arbitrage :

A currency arbitrage is a forex strategy in which a currency trader takes advantage of different spreads
offered by brokers for a particular currency pair by making trades. Different spreads for a currency pair
imply disparities between the bid and ask prices. Currency arbitrage involves buying and selling
currency pairs from different brokers to take advantage of the miss priced rates.

Currency arbitrage involves the exploitation of the differences in quotes rather than movements in the
exchange rates of the currencies in the currency pair. Forex traders typically practice two-currency
arbitrage, in which the differences between the spreads of two currencies are exploited. Traders can
also practice three-currency arbitrage, also known as triangular arbitrage, which is a more complex
strategy. Due to the use of computers and high-speed trading systems, large traders often catch
differences in currency pair quotes and close the gap quickly.

Currency Arbitrage Example:

For example, two different banks (Bank A and Bank B) offer quotes for the US/EUR currency pair.
Bank A sets the rate at 3/2 dollars per euro, and Bank B sets its rate at 4/3 dollars per euro. In currency
arbitrage, the trader would take one euro, convert that into dollars with Bank A and then back
into euros with Bank B. The result is that the trader who started with one euro now has 9/8 euro. The
trader has made a 1/8 euro profit if trading fees are not taken into account.
By definition, currency arbitrage requires the buying and selling of the two or more currencies to
happen instantaneously, because an arbitrage is something that is risk free. With the advent of online
portals and algorithmic trading, arbitrage has become much less common. With price discovery high,
the ability to benefit from arbitrage falls.

What are Forex Option & Currency Trading Options :

Forex option & currency trading options are securities that allow currency traders to realize gains
without having to purchase the underlying currency pair. By incorporating leverage, forex options
magnify returns and provide a set downside risk. Alternatively, currency trading options can be held
alongside the underlying forex pair to lock in profits or minimize risk. In this case, limiting the upside
potential is usually necessary for capping the downside as well.

Because forex option & currency trading options contracts implement leverage, traders are able to
profit from much smaller moves when using options contracts than a traditional retail forex trade
would allow. When combining traditional positions with a forex option, hedging strategies such
as straddles, strangles and spreads can be used to minimize the risk of loss in a currency trade.

Not all retail forex brokers provide the opportunity for option trading. Retail forex traders who intend
to trade options online should research prospective brokers because having a broker that allows you to
trade options alongside traditional positions is valuable. However, traders can also open a separate
account and buy options through a different broker. Because of the risk of loss involved in writing
options, most retail forex brokers do not allow traders to sell options contracts without high levels of
capital for protection.

There are two types of options available to retail forex traders for currency option trading: put/call
options and SPOT options.

Types of Forex Option & Currency Trading Options:

The call option gives the buyer the right to purchase a currency pair at a given exchange rate at some
time in the future. The put option gives the buyer the right to sell a currency pair at a given exchange
rate at some time in the future. Both the put and call options are a right to buy or sell, and not an
obligation. If the current exchange rate puts the options out of the money, then the options will expire
worthless.

Single payment options trading (SPOT) options have a higher premium cost compared to traditional
options, but they are easier to set and execute. A currency trader buys and a SPOT option by inputting
a desired scenario (e.g. "I think EUR/USD will have an exchange rate above 1.5205 15 days from
now") and is quoted a premium. If the buyer purchases this option, the SPOT will automatically pay
out if the scenario occurs. Essentially, the option is automatically converted to cash.

What is a Spot Trade?

A spot trade is the purchase or sale of a foreign currency, financial instrument or commodity for instant
delivery. Most spot contracts include physical delivery of the currency, commodity or instrument; the
difference in price of a future or forward contract versus a spot contract takes into account the time
value of the payment, based on interest rates and time to maturity. A spot contract is a binding
obligation to buy or sell a certain amount of foreign currency at the current market rate, for settlement
in two business days' time. To enter into a spot deal you advise us of the amount, the two currencies
involved and which currency you would like to buy or sell.

A spot trade can be contrasted with a forward or futures trade.

The Basics of a Spot Trade

Foreign exchange spot contracts are the most common and are usually for delivery in two business
days, while most other financial instruments settle the next business day. The spot foreign exchange
(forex) market trades electronically around the world. It is the world's largest market, with over $5
trillion traded daily; its size dwarfs the interest rate and commodity markets.

The current price of a financial instrument is called the spot price. It is the price at which an instrument
can be sold or bought at immediately. Buyers and sellers create the spot price by posting their buy and
sell orders. In liquid markets, the spot price may change by the second, as orders get filled and new
ones enter the marketplace.

Companies involved in international trade may be required to make payments, or to receive payments,
in a foreign currency. A spot contract allows a company to buy or sell foreign currency on the day it
chooses to deal

Settlement
A spot deal will settle (in other words, the physical exchange of currencies) two working days after the
deal is struck. The difference between the deal and settlement date reflects both the need to arrange the
transfer of funds and, the time difference between the currency centres involved.
 Forward Pricing
The price for any instrument that settles later than spot is a combination of the spot price and the
interest cost until the settlement date. In the case of forex, the interest rate differential between the two
currencies is used for this calculation.

 Spot trades involve financial instruments trade for immediate delivery in the market.
 Many assets quote a “spot price” and a “futures or forward price.”
 Most spot market transactions have a T+2 settlement date.
 Spot market transactions can take place on an exchange or over-the-counter
.

Summary
Forecasting exchange rates is very difficult. For a company to use only the spot market for its foreign
currency requirements may be a high risk strategy because exchange rates could move significantly in
a short period of time. For example, if you placed an order for raw materials from Germany for
payment in three months' time, and use the spot market to meet the invoice when it falls due, your
company could lose significantly if rates move against you.

Forward exchange contract

Overview of Forward Exchange Contracts

A forward exchange contract is an agreement under which a business agrees to buy a certain
amount of foreign currency on a specific future date. The purchase is made at a predetermined
exchange rate. By entering into this contract, the buyer can protect itself from subsequent
fluctuations in a foreign currency's exchange rate. The intent of this contract is to hedge a foreign
exchange position in order to avoid a loss, or to speculate on future changes in an exchange rate
in order to generate a gain.

Forward exchange rates can be obtained for twelve months into the future; quotes for major
currency pairs (such as dollars and euros) can be obtained for as much as five to ten years in the
future.

The exchange rate is comprised of the following elements:

 The spot price of the currency

 The bank’s transaction fee
 An adjustment (up or down) for the interest rate differential between the two currencies. In essence,
the currency of the country having a lower interest rate will trade at a premium, while the currency
of the country having a higher interest rate will trade at a discount. For example, if the domestic
interest rate is lower than the rate in the other country, the bank acting as the counterparty adds
points to the spot rate, which increases the cost of the foreign currency in the forward contract.

The calculation of the number of discount or premium points to subtract from or add to a forw ard
contract is based on the following formula:
Days contract duration

Premium/discount = Exchange rate x interest rate differential x -----------------------

360
Thus, if the spot price of pounds per dollar were 1.5459 and there were a premium of 15 points
for a forward contract with a 360-day maturity, the forward rate (not including a transaction fee)
would be 1.5474.

By entering into a forward contract, a company can ensure that a definite future liability can be
settled at a specific exchange rate. Forward contracts are typically customized, and arranged
between a company and its bank. The bank will require a partial payment to initiate a forward
contract, as well as final payment shortly before the settlement date.

The primary difficulties with forward contracts relate to their being customized transactions that
are designed specifically for two parties. Because of this level of customization, it is difficult for
either party to offload the contract to a third party. Also, the level of customization makes it
difficult to compare offerings from different banks, so there is a tendency for banks to build
unusually large fees into these contracts. Finally, a company may find that the underlying
transaction for which a forward contract was created has been cancelled, leaving the contract still
to be settled. If so, the treasury staff can enter into a second forward contract, whose net effect is
to offset the first forward contract. Though the bank will charge fees for both contracts, this
arrangement will settle the company’s obligations. An additional issue is that these contracts can
only be terminated early through the mutual agreement of both parties to the contracts.

Example of a Forward Exchange Contract

Suture Corporation has acquired equipment from a company in the United Kingdom, which
Suture must pay for in 60 days in the amount of £150,000. To hedge against the risk of an
unfavorable change in exchange rates during the intervening 60 days, Suture enters into a forward
contract with its bank to buy £150,000 in 60 days, at the current exchange rate.

60 days later, the exchange rate has indeed taken a turn for the worse, but Suture’s treasurer is
indifferent, since he obtains the £150,000 needed for the purchase transaction based on the
exchange rate in existence when the contract with the supplier was originally signed.
What is Forex Options Trading:

Forex options trading is a strategy for use in the foreign exchange (FX) marketplace which allows
traders to trade without taking actual delivery of the asset. Forex options trade over-the-counter
(OTC), and traders can choose prices and expiration dates which suit their hedging or profit
strategy needs. Unlike futures, where the trader must fulfill the terms of the contract, options
traders do not have that obligation at expiration.

Forex Options Trading:

Traders like to use forex options trading for several reasons. They have a limit to their downside
risk and may lose only the premium they paid to buy the options, but they have unlimited upside
potential. Some traders will use FX options trading to hedge open positions they may hold in the
forex cash market . As opposed to a futures market, the cash market, also called the physical and
spot market, has the immediate settlement of transactions involving commodities and
securities. Traders also like forex options trading because it gives them a chance to trade and
profit on the prediction of the market's direction based on economic, political, or other news.

However, the premium charged on forex options trading contracts can be quite high. The premium
depends on the strike price and expiration date. Also, once you buy an option contract, they cannot
be re-traded or sold. Forex options trading is complex and has many moving parts making it
difficult to determine their value. Risk include interest rate differentials (IRD), market volatility,
the time horizon for expiration, and the current price of the currency pair.

Forex Options Trading is a strategy that gives currency traders the ability to realize some of the
payoffs and excitement of trading without having to go through the process of buying a currency
pair.

Primary Types of Forex Options Trading

There are two types of options primarily available to retail forex traders for currency op tions
trading. Both kinds of trades involve short-term trades of a currency pair with a focus on the
future interest rates of the pair.

1. The traditional call or put option. With a traditional, or vanilla, options contract the trader
has the right but is not obligated, to buy or sell any particular currency at the agreed upon
price and execution date. The trade will still involve being long one currency and short
another currency pair. In essence, the buyer will state how much they would like to buy,
the price they want to buy at, and the date for expiration. A seller will then respond with a
quoted premium for the trade. Traditional options may have American or European style
expirations. Both the put and call options give traders a right, but there is no obligation. If
the current exchange rate puts the options out of the money (OTM), then they
will expire worthlessly.

2. A single payment option trading (SPOT) is a more flexibility contract structure than the
traditional options. This strategy is an all-or-nothing type of trade, and they are also known
 as binary options. The buyer will offer a scenario, such as EUR/USD will break 1.3000 in
12 days. They will receive premium quotes representing a payout based on the probability
of the event taking place. If this event takes place, the buyer gets a profit. If the situation
does not occur, the buyer will lose the premium they paid. SPOT contracts require a higher
premium than traditional options contracts do. Also, SPOT contracts may be written to pay
out if they reach a specific point, several specific points, or if it does not reach a particular
point at all. Of course, premium requirements will be higher with specialized options
structures.

Not all retail forex brokers provide the opportunity for options trading, so retail forex traders
should research any broker they intend on using to ensure they offer this opportunity. Due to the
risk of loss associated with writing options, most retail forex brokers do not allow traders to sell
options contracts without high levels of capital for protection.