One strategy used in binary options trading that is commonly misunderstood and utilized is using the investment as a hedge against another investment. Hedging can and will be the biggest strategy tool and will be of a great help if understood correctly. We will explain in detail below to help understand the term better, and how it can be used correctly in binary options trading.
Hedging and Asset Classes
Hedging can be used in any asset class of trading, but is more commonly used in currency trading. Minimizing risk is the basic idea of hedging with all asset classes. It will be of great use no matter if you’re original option is trending to finish in our out-of-the-money.
Call and Put
Always remember in binary options that a Put simply means that you think the asset will fall in value. Call means that it will rise in value. It is important to know the difference between the two when trading.
A good example would be to take a call option on an asset. This option expires in 30 minutes after the initial trade. So if you are an avid investor that is familiar how the set times are, then you will pay close attention to what the asset does over the next 15 or 20 minutes.
There are two basic choices if and when the asset moves to an in-the-money position. The first one is to wait out the trade until the expiry. If this basic option is taken then you will win the payout percentage if the option finishes in-the-money, or if it suddenly drops in value then you will lose 85% and finish out-of-the-money.
Let’s look at the scenario if the asset rose from the time the option was taken. Currently you are in-the-money, but there is still some time left until expiry. So, now utilizing a hedge, you have the choice of taking out an option of the opposite movement. You can take a PUT option if the original was a CALL option.
- The result from making a Put trade at expiry if the option is above the level would be the following: you are in-the-money on the Call option and out of the money on the Put option. In this circumstance the loss would be a small percentage of the combined investments which normally equal out to be around 5%. The actual loss will mirror the payout for the call option and the return percentage for the out-of-the-money put option.
- The result of making the Call option at time of expiry when it is below the level would be in-the-money for the Put option and out-of-the-money on the Call option. This is considered a classic hedge situation if your option trade was in a good position at the start and you hedged against a reversal with the performance of the asset. The end result would minimize your loss to 5% when hedging or 85% without.
- If, the asset has fallen below the strike point when the Put option was taken at expiry, but is still above level when the Call option was made, then the result would be in your favor with a big congratulation in order. Both of the trades have finished in-the-money and you receive a payout percentage for each of the options taken. The result of being successful receiving a nice profit comes with making the push as the hedge against the reversal of fortune that was relative to the original call option.
This is a prime example that shows one can win with the hedging option as well with the original option. The scenario will often occur when there is a large difference between the two strike points; the one with the call option and the one with the put option. If, at a point you are certain the option will finish in-the-money, you can choose not to use a hedge. However, hedging is a great option and strategy to use when bot the gap between the two strike points is significant and even when the gap is small. In other situations or cases, there is a big possibility that the asset price will change in direction. If this happens, a hedge option will greatly reduce the loss to 5% as seen above in the example. If you decide not to hedge, then the asset could finish out-of-the-money resulting in a 85% loss.
Hedging is a great strategy for most binary options trades, especially for Call and PUT trades, but also works well with all range and touch/no touch options as well. Denise Marie really enjoys writing about Forex and Binary Options. Denise is not a financial advisor and the article is for educational purposes only.