A zero cost option strategy is also known as a risk reversal strategy or a zero-cost hedge. This FX option allows you to be hedged at a pre-defined rate while benefitting from the market’s favourable moves up to a specified cap level. With these options, you may be required to trade at the expiry point, and your gains will be capped if they pass a certain point.

Basically, this option allows you to buy an out-of-the-money put option (which requires someone to purchase currency at a price below the current value) and to sell an out-of-the-money call option (an option to purchase currency at a price above the current value) for the same price. The result is zero net costs for the transaction, as the put option purchase is offset by the call option sale.

This zero cost option strategy locks in the highest potential gain and the highest potential loss on holding the currency. The currency is used only to reduce risk when you buy currency that previously experienced large gains, with the intention of holding it for a long period of time. That said, you also need to be able to buy and sell options at the same price.

Many FX traders use zero cost options in markets that are experiencing a decline, as the strategy’s main purpose is to limit risks associated with a currency exchange rate dropping. The put option protects you from losing most of the gains the currency experienced (as far as the strike price of the put option) without the need to sell the currency immediately.

However, the cost of a put option doesn’t often match up perfectly with a call option selling price, which can make it difficult to use this strategy. With this in mind, the strategy is a good one to use if you want to get as close to breakeven as possible when you buy and sell opposing options.

Advantages and disadvantages of a zero cost option

There are several advantages and disadvantages to zero cost options. It’s best to familiarise yourself with them before deciding to use this option as one of your foreign exchange strategies.

One of the biggest advantages is that you do not need to pay an upfront premium when you choose this option. Other advantages include the option offering protection against unfavourable movements in a currency market, and you being able to benefit from rates between the floor and the cap.

One of the biggest disadvantages of this option is that it limits your ability to profit from currency appreciation. Other disadvantages include potential extra costs for you at the termination of the option (market rate dependent), and the possibility of getting a better rate if you use a forward contract instead.

Sign up for a business account with Moneycorp

Like other options, a zero cost option can be a powerful strategy for reducing your exposure to the risks associated with significant fluctuations in a foreign exchange market. This, along with other options, are one of the many FX solutions we offer. Sign up for a business account with Moneycorp, discover the various solutions we offer, and choose those that best meet your needs.