Options Combinations and Strategies

Combination of options are used among the professionals for many purposes, including taking directional views on currencies anticipating that a particular currency will move up or down as well as taking volatility views on currencies anticipating that a particular exchange rate will vary by more or by less than the market expects.

Among the options combination that are currently most widely used by traders in the OTC market are the following:

A straddle consists of one put and one call with the same expiration date, face amount, and strike price. The strike price is usually set at the forward rate or “at the money forward” (ATMF) where the delta is about 0.50.

A long straddle gains if there is higher than forecast volatility, regardless of which of the two currencies in the pair goes up and which goes down—and any potential loss is limited to the cost of the two premiums. By the same token, a short straddle gains if there is less than expected volatility, and the potential gain is limited to the premiums. Thus, a trader buys volatility by buying a straddle, and sells volatility by selling a straddle. Straddles account for the largest volume of transactions in interbank trading.

A strangle differs from a straddle in that it consists of a put and a call at different strike prices, both of which are “out of the-money,”
rather than “at-the-money.” Often the strike prices are set at 0.25 delta. It is a less aggressive position than the straddle a long strangle costs less to buy, but it requires a higher volatility (relative to market expectations of volatility) to be profitable.


A risk reversal is a directional play, rather than a volatility play. A dealer exchanges an out of themoney (OTM) put for an OTM call (or vice versa) with a counter party.
Since the OTM put and the OTM call will usually be of different values, the dealer pays or receives a premium for making the exchange. The dealer will quote the implied volatility differential at which he is prepared to a make the exchange.

“For a three-month 0.25-delta risk reversal, 0.6 at 1.4 Swiss calls over.” That means the dealer is willing to pay a net premium of 0.6 vols (above the current implied ATM volatility) to buy a 0.25-delta OTM Swiss franc call and sell a 0.25-delta OTM Swiss franc put against the dollar, and he wants to earn a net premium of 1.4 vols (above the current implied ATM premium) for the opposite transaction. The holder of a risk reversal who has sold an OTM put and bought an OTM call will gain if the call is exercised, and he will lose if the put is exercised—but unlike the holder of a long straddle or long strangle (where the maximum loss is the premium paid),on the put he has sold his potential loss is unbounded.