A seagull option is a fanciful name for a type of investment strategy that is sometimes used in currency trading circles. The process involves using a combination of purchases and sales on the currency options involved in an attempt to keep the risk level of the investment within reason. In addition to minimizing risk, the use of a seagull option is relatively inexpensive, especially when considering the amount of protection that can result from the arrangement.
The basic structure of the seagull option involves the creation of a hedge that helps to protect the investor from incurring a loss on the currency trade. This is managed by purchasing a call option while also selling a put option, or creating a combination that involves a call option for sale and a the purchase of a put option. This arrangement allows the investor to exercise whichever option is in line with what takes place on the foreign exchange or Forex market, and still be able to generate some return from the trade.
In order for the seagull option to function properly, it is essential that the two options involved are equal in terms of amount, and that the options are priced in a manner that will effectively create a zero coupon. With this arrangement, the investor is effectively insulated from situations in which there is a high level of volatility, and there is a strong indication that significant changes in the rate of exchange will soon occur, but without any solid indication of what direction that rate will move. As the movement becomes apparent, the investor can simply exercise the option that will provide the most benefit while allowing the other option to lapse.
As with any type of investment strategy, the seagull option calls for choosing the right combination of puts and calls, and making sure the expiration dates for the options are in line with the expectations for those shifts in the rates of exchange. Taking the time to project the outcome based on more than one potential movement of the rate of exchange is a good way to test the likely results of the combination under consideration. While this particular option strategy will help to reduce the level of risk assumed by the investor, the arrangement does not completely remove all volatility. There is still the chance that the return will be more modest than anticipated, especially if the movement on the exchange rate is not as significant as anticipated.
