Hedging using FX options
Options are often used as a hedging tool for a spot position. Hedging strategies are usually used to reduce a potential loss on the investment. If the investor buys a spot position at a price of 100, he/she has a profit/loss scenario as shown in the left-hand figure below. If the investor buys a put option, he can change the profit/loss scenario and reduce a potential loss. This is illustrated in the right-hand graph below.
The advantage of hedging with options instead of using a "stop" is that you will stay in the market despite temporary movements against your underlying position and still have an unlimited profit scenario. Hence, if the spot temporarily goes against the your Long position but ends up increasing in the long-run, you will still show a profit because you hedged your position. If, however, you had used a stop order, you would have been taken out of the position at the lower stop-price and would thus show a loss. The disadvantage is that you must have a larger gain in the spot before the position makes a profit because you must pay the option's premium.