Hedge the news with Binary Options

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Hedge the news with Binary Options

Good Day traders,

In this article I am going to explain you a very simple but effective system from which you can make a sure profit using binary options. I use this strategy sometimes, mainly when we have news realises. Where is the problem with news realises? The market always is makes the big move some seconds after the announcement. You can know what time is the announcement but you can’t know exactly some seconds after it.You can know it about one minute later when the economic sites will post the announcement. So, what I do? Let’s assume that we have news at 11:30 AM. I use two monitors. One for the charts and another one for the orders.I was waiting to close the last candle one minute before the news, at 11:29 AM, and in the next candles, the news candle I am looking for buying or selling climax. If the candle starts to be green this means heavily buying activity some seconds after the news, the market will move up.If the candle starts to be red with selling climax this means heavily selling activity and the market will go down. Sometimes we have a correction exactly after this candle and the market goes to the opposite direction but the most of the time the first candle after the news, the news candle as I call it show us the way. To avoid unpredictable conditions like the condition I said above you can do one simple thing. Hedging the news. For doing this you can use two different financial products in the same asset. Spread Trading or Spot FX and Binary options. I take my main position usually with a Spread Trade and I am hedging this position with a binary option contract. Let’s see an example.

Look at this chart. It’s from GBPUSD currency pair. In the blue rectangle I drew we have the “news candle” (the big bullish candle). Now, let’s assume that your max loss you want for the Spread Trade or Spot FX is about 40$ and this will be your stop loss. You take a trade with 1 Lot or 10$ per pip. When the news candle starts to have buying climax the market shows us the way. You open your buying position. The same time open a binary option contract in the opposite direction, take a 50$ put. So,

Scenario 1: The price moved up about 35 pips and you made 350$ from the Spread Bet but you lost 50$ of the binary option contract. Total profit 300$.

Scenario 2: The first reaction of the market was false and it moved in the opposite direction. Your Spread Bet stopped at 40$ loss (stop Loss order) but you won the binary options (payout 70-80%) can give you about 40$ profit. Your total profit is 0$.

How to Hedge Stock Positions Using Binary Options

Binary option trading had been only available on lesser-known exchanges like Nadex and Cantor, and on a few overseas brokerage firms. However, recently, the New York Stock Exchange (NYSE) introduced binary options trading on its platform, which will help binary options become more popular. Owing to their fixed amount all-or-nothing payout, binary options are already very popular among traders. Compared to the tradition plain vanilla put-call options that have a variable payout, binary options have fixed amount payouts, which help traders be aware of the possible risk-return profile upfront.

The fixed amount payout structure with upfront information about maximum possible loss and maximum possible profit enables the binary options to be efficiently used for hedging. This article discusses how binary options can be used to hedge a long stock position and a short stock position.

Quick Primer To Binary Options

Going by the literal meaning of the word ‘binary,’ binary options provide only two possible payoffs: a fixed amount ($100) or nothing ($0). To purchase a binary option, an option buyer pays the option seller an amount called the option premium. Binary options have other standard parameters similar to a standard option: a strike price, an expiry date, and an underlying stock or index on which the binary option is defined.

Buying the binary option allows the buyer a chance to receive either $100 or nothing, depending on a condition being met. For exchange-traded binary options defined on stocks, the condition is linked to the settlement value of the underlying crossing over the strike price on the expiry date. For example, if the underlying asset settles above the strike price on the expiry date, the binary call option buyer gets $100 from the option seller, taking his net profit to ($100 – option premium paid). If the condition is not met, the option seller pays nothing and keeps the option premium as his profit.

Binary call options guarantee $100 to the buyer if the underlying settles above the strike price, while binary put option guarantees $100 to the buyer if the underlying settles below the strike price. In either case, the seller benefits if the condition is not met, as he gets to keep the option premium as his profit.

With binary options available on common stocks trading on exchanges like the NYSE, stock positions can be efficiently hedged to mitigate loss-making scenarios.

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Hedge Long Stock Position Using Binary Options

Assume stock ABC, Inc. is trading at $35 per share and Ami purchases 300 shares totaling to $10,500. She sets the stop-loss limit to $30—meaning she is willing to take a maximum loss of $5 per share. The moment the stock price falls to $30, Ami will book her losses and get out of the trade. In essence, she is looking for assurance that:

  • Her maximum loss remains limited to $5 per share, or $5 * 300 shares = $1,500 in total.
  • Her pre-determined stop-loss level is $30.

Her long position in stock will incur losses when the stock price declines. A binary put option provides a $100 payout on declines. Marrying the two can provide the required hedge. A binary put option can be used to meet the hedging requirements of the above-mentioned long stock position.

Assume that a binary put option with a strike price of $35 is available for $0.25. How many such binary put options should Ami purchase to hedge her long stock position till $30? Here is a step-by-step calculation:

  • Level of protection required = maximum possible acceptable loss per share = $35 – $30 = $5.
  • Total dollar value of hedging = level of protection * number of shares = $5 * 300 = $1,500.
  • A standard binary option lot has a size of 100 contracts. One needs to purchase at least 100 binary option contracts. Since a binary put option is available at $0.25, total cost needed for buying one lot = $0.25 * 100 contracts = $25. This is also called the option premium amount.
  • Maximum profit available from binary put = maximum option payout – option premium = $100 – $25 = $75.
  • Number of binary put options required = total hedge required/maximum profit per contract = $1,500/$75 = 20.
  • Total cost for hedging = $0.25 * 20 * 100 = $500.

Here is the scenario analysis according to the different price levels of the underlying, at the time of expiry:

Hedging No-Touch Binary Options with a Spot Forex Position

What Is ?

First off, if you are not familiar with a option, it is a simple variation on a One Touch option. One Touch options are some of the most common binary options. When you purchase a One Touch contract, it works like this: You look at a given asset, and you wager that the price will touch a certain trigger value before the binary option expires. If you are right, you win a payout. If you are wrong, you lose the trade. A trade is the same thing, except you wager price will not reach the trigger value.

options are an interesting opportunity, because you are able to profit from the market not moving. You cannot do that in Forex, because in FX, you can only profit off of price rising or falling. Nonetheless, a lot of Forex traders avoid binary options because they are expensive. A winning trade typically pays out 65% to 85%, but a losing trade will usually only carry a 10% refund. There’s a gap there in the broker’s favor, and it can add up to more than your Forex spread. You may feel more comfortable trading a binary option if you can take some of the risk out of the equation, and that is where hedging comes into play.

How to Hedge Your Option

Anytime you hedge while trading, you are covering all your bases by setting yourself up to try and profit regardless of what the market actually does. Let’s look at three ways you can approach your binary options trade:

No Hedge

If you don’t hedge your trade at all, your risk depends on how much you have staked on the trade. If you win, you will probably get around 75% of your investment as profit. If you lose, you will lose the majority or all of your stake; a 10% refund is typical. Calculating your risk is easy, but you haven’t done anything to reduce it.

Simple Hedging Without a Stop Loss

Let’s say you decide that your risk is too high on your trade, and you want to do a basic hedge. Open up your Forex account, and navigate to the right currency pair. Take a look at your option. Are you wagering that price will not go up, or that price will not go down? If you are wagering price will not go up, then in your Forex account you will be placing a buy order. If you are wagering price will not go down, then in your FX account you will be placing a sell order. Set your to the value of the trigger level in the trade.

If you set your position size in Forex to the same amount you are risking in your trade, and the trigger value is hit, you will lose your binary options trade, and win the same amount back in FX. The result is a breakeven, and a profit (and loss) of $0.00.

If the trade doesn’t reach the trigger value but moves in the same direction, you have a shot at winning both your trades. Of course, if the binary option wins, but the currency moves down, you will lose the currency trade. And the danger of not setting a stop is that you could have potentially infinite losses on the FX trade. So if the Forex trade falls far enough, it could eliminate your binary options winnings, and even land you in the red.

Simple Hedging with a Stop Loss

The logical thing to do to prevent infinite losses in your Forex account is naturally to set a stop loss. There are numerous different techniques you can use to set a stop loss; the best ones usually are those that have some basis in what price is doing (support or resistance, a Fibonacci level, etc.). The tighter your stop, the less money you can lose. But don’t forget that a stop which is too tight can stop you out of a trade you might otherwise have won. You’ll need to do some testing to decide on an optimal stop loss strategy.

Setting a smart stop loss and hedging that way typically leads to a more positive outcome. You have several chances to attain profit on one or both trades. There is still the possibility of a breakeven result, but the odds of a loss decrease and your loss will be finite.

Conditional Hedging with a Stop Loss

Does your binary options broker provide you with an early closure feature to get out of a trade early? The conditional hedging scenario is more or less the same setup as above, but you take advantage of the early closure tool if your stop loss is triggered (in your Forex trade). The trade will close “in the money” and pay out a partial profit. While the profit will be small, it may cover some of your Forex losses. When you trade using this method, you still may lose money, but it becomes more likely that you’ll be able to cut your losses—and you still may profit, even in a scenario.

Use a Hedging Calculator to Choose Your Approach

How do you decide which type of hedging tactic to employ? As you have probably realized, there are a lot of complex calculations you can do for any given trade which will exactly tell you what your risk is given a variety of different scenarios. If you are totally confident in your trade, you may not have a need to hedge. Otherwise, you can save yourself a lot of time (and mathematical errors) by using a hedging calculator for binary options.

With this calculator, you can input your binary account currency, the option price and payout for a given currency pair, the strike rate, the current bid rate for the currency, the price, and the type of hedging method you are interested in (any of the method above). The calculator will generate a set of possible outcomes based on the information you have provided and the method you have selected. The result? An exact calculation of your possible losses or gains. Try running through the information with each hedging approach, compare the results, and see which method is likely to reduce your risk exposure the most and give you the best chance at success. Hedging is a great way to protect your account from losses. With the aid of this calculator, you can save time and money on your journey toward profit.

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