Wednesday, June 8, 2011

Popular Binary Option Trading Strategy Types

Binary options have become increasing popular as a trading vehicle for those interested in speculating on forex rates, commodity prices, stock prices and market indexes.

Although usually traded from the long side, binary options can be combined into several option trading strategy types that are similar to those described in just about any option trading guide that focuses on strategies involving regular or “vanilla” options.

The primary difference seen with binary options is that they have a fixed payout at expiration, rather than the time and price sensitive payout that is characteristic of vanilla options.

Binary options also tend to be traded with considerably shorter maturities than vanilla options, often expiring one week to less than one hour from initiation of the binary option position — depending on what the binary option brokerage used offers.

The following sections will cover some of the more common binary option trading strategy types employed by retail traders with access to a binary options broker.

Purchased Binary Call Option Trading Strategy

This option trading strategy involves paying an up front premium to purchase a binary call option that will pay out a fixed amount if the underlying market is above its strike price at expiration.

Traders might use this bullish option trading strategy if they thought the market might rise by expiration, but they did not wish to take the added risk of stop loss sell order slippage or being triggered on a stop loss sell order before ultimately being proved correct on the market’s anticipated upward direction.

Purchased Binary Put Option Trading Strategy

This option trading strategy involves buying a binary put option for an up front premium that will pay out a predetermined amount if the underlying’s market price is below the option’s strike price at its expiration time.

Traders could employ this bearish option trading strategy if they anticipated that the market could fall by its expiration time, and they wanted to avoid the added risk of stop loss buy order slippage or being triggered on a stop loss buy order before the market eventually moved in the anticipated downward direction.

Purchased Binary Straddle Option Trading Strategy

This option trading strategy involves purchasing both a binary put option and a binary call option at the same strike price that is usually close to at the money in return for an up front premium. These binary options will each pay out a fixed amount if the underlying market is better than their identical strike price at expiration, but they will both not pay out at the same time.

Traders might employ this usually initially neutral option trading strategy if they expected the underlying market to move significantly by expiration, but they were not sure in what direction it might go.

In addition, they might buy a straddle made up of binary options if they did not want to take the extra risk of slippage on stop loss orders or being triggered on stop loss orders after initiating a position in a particularly volatile market.

Purchased Binary Strangle Option Trading Strategy

This option trading strategy involves paying an up front premium to purchase both a binary call option and a binary put option at different strike prices that are usually a similar amount out of the money. Each leg of the strangle will pay out a fixed amount if the underlying market is better than their strike price at expiration, but both legs will not pay out at the same time.

Traders might use this usually initially neutral option trading strategy if they thought the underlying market might move substantially by expiration, but they did not know in which direction.

Furthermore, they might use a strangle consisting of binary options if they did not wish to take the added risk of stop loss order slippage or being triggered on a stop loss order after opening a position in an especially fast market.

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13 comments:

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