A Beginner’s Guide to Seagull Options
While trading in the market, traders implement various strategies to hedge their trade against any possible risks. Such hedging techniques require thorough research and meticulous calculations on their part so that they can minimise their losses.
Seagull option trading is one such technique that traders implement while dealing with currencies. It helps them downsize their premium cost to a zero premium structure. Not just that, it also helps them bring down the risk levels to a more digestible height.
What is a Seagull Option?
Alternatively known as the three-legged option trading strategy, the seagull option is a complicated trading strategy. The term “three-legged strategy” comes from the fact that there are three options that make up this strategy. It consists of two call options and one put option, or one call and two put options. Traders use this strategy to hedge themselves against any unfavourable forex market movements.
What are the features of Seagull Options?
Taking a closer look at some of the salient features of this trading strategy will help in a better understanding of the same. These features include:
- The seagull option strategy is used to hedge risk against the movement of the underlying foreign currency while trading.
- You can use this technique to either control the upward movement or the downward movement of the relevant currency. You can, however, not use it to control both movements at the same time.
- All three options that consist of the seagull option strategy must have the same expiry date.
- The notional value of all options must also be the same.
How to construct a Seagull Option?
A trader can primarily use seagull options in two different combinations, i.e. importer seagull and exporter seagull. Both are a part of seagull option trading and are implemented to hedge trades in different scenarios.
- Importer seagull
An importer seagull is implemented at the time of foreign currency payables. Since the seagull option is a three-legged strategy, the importer seagull also involves three options. It is formed by combining a buy of one call option, a sale of one call option, and a sale of one put option. If you look at it from a different angle, you can call it a blend of a call spread strategy and a sell put option.
- Exporter seagull
The exporter seagull option is exactly the opposite of the importer seagull option. As you might have already guessed by now, it is implemented in the case of foreign currency receivables.
Just like importer seagull, it also consists of three options, but their composition is different here. It is made up of two put options and one call option. Here, a put option is bought, and another put option is sold along with the call option.
The major differentiating factor between importer and exporter seagull options is the composition of both of these strategies. However, apart from that, all the key features mentioned above for a seagull option strategy continue to hold true in both cases.
Limitations of Using Seagull Options Trading
We have already understood that seagull option trading is a technique that traders use to hedge against any unfavourable forex movement. But with this strategy, the biggest limitation they face is capped gains.
Because this trading strategy allows traders to set off their premium cost by selling two options, it also limits the gains they can make with it. Therefore, If you are expecting to make high profits, this might not be the right strategy to use.
Seagull options trading is a very technical and highly complicated strategy. It is more suitable for traders who possess the knowledge and understand the market in depth.
Various factors come together to form the basis for the choice of strategies that experienced traders implement. A lot of research goes into an individual option contract. Therefore, a strategy wherein you need to choose three options and ensure you have made the right combination requires serious skills. If you have just started, it is advisable to get comfortable with the basics first, before taking the more complicated routes.
Frequently Asked Questions
What are the types of risks associated with seagull option trading?
Out of the several types of risks involved with seagull options trading, market risk, settlement risk, pre-settlement risk, liquidity risk, and credit risk are a few of them. The risk factor, however, is not just limited to these. Make sure to understand the risk factor associated with your trade before entering into one.
What are the components that determine the value of options for seagull trading?
Several components make up and influence the value of an option. Some prominent determinants are the spot rate, strike rate, and forward rate of the option. Other factors that influence the cost are volatility, the tenure of the contract, and interest rate differentials.
I am a beginner and am still learning the know-how of trading. Can I practice Seagull options?
As long as you are using practice platforms to learn about it and not using real money, you definitely can. Because it is a complex strategy, the chances of a beginner losing money are higher; hence, it is advisable to act with caution.
If I can make more money without using seagull options, then why should I use them?
Forex movements are very volatile, and without seagull options, you can face heavy losses. Seagull options limit your losses and, as a result, cap your gains too. So if you wish to skip this strategy, do it only if your appetite for risk allows you.