5 Advantages of Forex Options Trading

By now, you've probably begun to hear about the new anti-hedging regulation the NFA is about to impose. This can be pretty inconvenient for some trading styles, but don't be ready to move all of your money offshore yet. The NFA also gave traders a HUGE benefit as part of the same new regulations.

First, let's get the bad stuff out of the way.

As of May 15th, 2009, hedging won't be allowed on NFA registered brokerages. What this means is that you won't be able to have any new long and short positions on the same currency pair at the same time. Not all brokerages permitted this, but hedging ability is standard for MT4 accounts and does work with other forex trading platforms.

Usually, to open a long and a short on the same pair is silly, but there are legitimate reasons to do this. Some EAs us a hedging strategy. Some traders (myself included) might have long term positions in one direction and want to take short term trades in the opposite direction while letting the long term trades run. Also, when a trader has been foolish enough to let a position run far against him with no stoploss, opening a hedged position locks in the loss to that level, giving the trader time to contemplate the unpleasant choices left available (at least until swap fees or widened spreads finally eat all remaining available margin). Just to be generous, they announced this on the 13th of April so that those of us who hedge would have month to adjust our strategies. Nice to know that they expect people to be able to take strategies developed over months or years and adjust them in only 1 month.

For those who want to hedge, there are several options. At least 1 brokerage is trying to determine if hedging can be done intra-day and that opposing positions will only automatically close at rollover time. Other brokerages that have licensed offices both inside and outside the USA are allowing US clients the option of moving to one of their offshore branches.

Another choice would be to open a second account at your brokerage and place your hedges in the other account. For those who like to leave long term trades open while making short term trades, this would work well. For someone trying to buy time to think of options during severe drawdown, it would fail. For forex robots that hedge, it would fail.

Other options are “synthetic hedges”. This would involve opening trades on related, but not identical pairs. The EUR/USD and GBP/USD tend to move in the same general direction much of the time, so if you wanted to trade opposite of a EUR/USD long, you could open a GBP/USD short. The EUR/USD and USD/CHF are inversely correlated, so if you wanted to hedge a EUR/USD long, you could open a USD/CHF long. Forex trading robots that hedge normally would need to be reprogrammed for this to work.

I contacted several brokerages and asked them a simple question. If I have a long position on the EUR/USD and try to open an equal sized short position, what happens? The possibilities are: 1. It won't let me open a short position. 2. The positions will cancel out, thus closing my long trade. 3. Positions will open, but will cause close outs at rollover time. None of the brokerages were sure, but said that they would have answers soon – I hope before May 15th. Judging from the lack of solid answers from the brokerages, this was definitely not their idea and they are scrambling to find ways to deal with it.

Assuming trades are forced to be closed (instantly or at rollover), the rule seems to be FIFO – first in, first out. Thus, if you open a 0.8 lot long on the EUR/USD, then a 0.5 lot long on the EUR/USD, opening a 0.5 lot short on the EUR/USD will close 0.5 lot of the first 0.8 lot EUR/USD long that you opened.

Why did the NFA do this? My personal theory is that they accidentally took the wrong medications one morning, but they do claim to have had some real reasons. For inexperienced traders, a broker might encourage hedging just to collect more spread. An unscrupulous account manager could open hedged positions and later close the half that was in profit to show profits (at least for clients who are not bright enough to ask about currently open positions) and collect performance fees. Some people might be stupid enough to leave hedged positions open for long periods while the swap fees eat their remaining account balance.

Overall, I find these reasons to be very inadequate. Truly stupid traders will find a way to get margin called very quickly without the NFA messing with those who have legitimate reasons to open opposing positions. Some people need training wheels to learn to ride a bicycle, but this is the same as forcing all of us to have training wheels on forever for the sake of a few perpetually unbalanced people. The sad part it that in this time of economic upheaval, I'm sure this will cause a number of traders to move their accounts to offshore brokerages. Very likely, some of these brokers will scam the traders out of their money. Also, some US brokerages will end up hiring fewer workers or laying off workers because of reduced business volume. Way to go NFA! Save a tiny amount of money for a few people and end up costing jobs and making others move their money out of the country to banks and brokerages that are at least potentially riskier.