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.

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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.

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 With Binary Options

Binary options are a growing form of investment, simplifying the process of trading for many investors – but does the simplicity of a binary option open up opportunities beyond an introduction to trading? Could they, for example, be an ideal tool for risk management and hedging other investments ?

Define Hedging

A hedge, in terms of investment, can be loosely defined as;

“An investment made to mitigate risk in the event of adverse price movement of an asset.”

So hedging is a risk management strategy, offsetting an existing position in a related asset, or group of assets.

The most obvious “real world” example is an insurance policy. The policy protects the holder in the event of a particular event. In order to secure this protection however, the policy holder must pay for it. So a homeowner might insure their property, knowing that in the event of the property being damaged or destroyed, they would receive compensation. The trade off is that were nothing to happen to the property, the regular insurance premiums would erode some of the capital gains made.

The aim of hedging an investment then, is to mitigate any potential losses. Either from a particular event, or simply volatility. An investor may be cautious of a future event and wish to protect their investment. Simply closing and re-opening a position is not always easy, or cost effective. A trader may wish to continue holding their position, but simply apply some risk management.

This risk mitigation exercise could be necessary for a variety of reasons. A specific announcement, a global or domestic crisis, a key vote or any event – known or otherwise – that might affect the value of an asset.

How to hedge with binary trading

So given the fundamental aim of hedging an investment – could a binary option offer a flexible method of hedging? With costs, and potential returns, established before the trade is placed, traders can manage their level of risk with huge accuracy.

A hedged trade using a binary option

Let us look at a simple, fictional, example;

Our trader has a large holding in HugeCorp Plc. There is a concern that an upcoming court ruling regarding a patent will significantly affect the share price, perhaps knocking 10% off the current value. The trader is confident the ruling will be made in favour of HugeCorp – but wants to mitigate the risk.

Our trader opens a binary trade – with an expiry date shortly after the date of the ruling. If the price is below today’s value at the point of expiry, the trade will return 95% on his investment. If the price on expiry is above today’s valuation, the binary option will lose. The size of the option can be tailored however the trader chooses, enabling the risk to be managed to a precise level.

Our trader has mitigated the risk of any adverse news. Should the ruling go against HugeCorp, the option pays off – reducing losses. If the news is good, the binary option will lose – but the original holding in HugeCorp will have risen in value, mitigating the small loss on the binary option trade.

A binary option then, can provide an excellent hedging tool, particularly when considering a specific event, where the date is known. More elaborate options could be used, beyond the simple Higher/Lower type. For example an In/Out option might be used to protect against flat markets or delayed events.

Finding The Right Broker

In order to use binary options for hedging purposes, traders need to be very selective with their broker choice. A fundamental part of the hedge will be the time frame. The majority of these ‘hedge’ investments will be longer term, or for a specific event. Either way, the trader will require a large element of flexibility from their broker. Some brokers will not provide long term expiry times at all, others may provide ‘set’ long term expiries, for example, 3 months from today’s date, or 6 months. Binary.com however, allow traders to set their own expiry date – any date they choose. This level of flexibility means traders can be very specific and ensure their positions expire exactly when they need them to – for example directly after a key announcement.

In summary then, binary options are a great tool for those traders wishing to hedge related investments. The absolute control of the value and expiry date of the trade, make them perfect for risk management as potential losses and gains are known at the outset with absolute accuracy.

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