How do options affect the price of a currency?

[Zigrivers]

I was wondering if some of you more experienced derivitive traders could explain the impact of option expiration on the price of a currency?

From time to time I'll read posts saying that there is a large option expiring at a particular price and because of that the price of the currency is not expected to exceed it. I'll also read that the large option holder(s) will likely be "protecting" their position, which in turn is supposed to cap the price of the currency. I'd like to understand the mechanics better so that I can make my own judgements on the situation.

I understand what options are, but I'm still struggling to understand how they affect the underlying currency when they expire, or are excercised.

Lastly, how much impact do options really have on price based on your experience?

Hopefully, others will find this information useful as well.

Thanks!

[mishak]

Hi Zigrivers

Well, we are speaking here about OTC options sold by big players. Usually big banks offer various kind of barrier options to their big commercial clients (and maybe bank counterparts).
This make hedging cheaper for clients (or big bets on interbank market).
Big payout occurs when some specific price level is broken. So, players may wish to protect it (say 0.7350 in AUD) by selling (AUD) on spot.
This may work well in ranging market, but not very good now with long major downtrend in USD.
OTC options are usually have round figure strikes and expire in London (15:00GMT). However may be specifics in strikes and cut times - Tokyo cut (6:00 GMT) or NY cut (12:00 NY time).

Such kind of options may block the price movement in thin or ranging markets or when trend is exhausting. They may delay the price action for couple days in trending markets.

You may consider them as some resistance levels. When they expire they just disappear. When taken you may expect follow thru up to 50 pips.

[Mongoose]

It's pretty simple really:

The option WRITER will try to move the market (pair) out of the money so that the option expires at parity or better

The option BUYER will try to move the market (pair) into the money so that the option expires at parity or better

This will only happen if it is financailly viable and within risk parameters, and if the costs of moving the market is less than the potential reward from the option.

I tend to witness that option WRITERS have a more active roll than option BUYERS and that price is moved in their favour.

That said, i have no statistical backup for my claims, but I have observed this behaviour, and noticed it's prescence.

Mongoose