Binary Options Trading

Hedging and Binary Options

Hedging is a specific technique used in many different types of investing – including binary option trading – in which the investors takes two opposing positions in order to limit their exposure to loss. Although it is a relatively simple concept, hedging is one of the most powerful constructs in investment, and can be extremely effective in binary option trading. In fact, while hedging with many instruments can be quite confusing, in the case of binary options it is extremely straight forward, as there are many less variables to worry about.

The most basic type of hedging with binary options involves taking an opposing position on the same asset during the life of a contract, at a slightly different strike point. Understanding it is not terribly difficult, but example is by far the easiest way to get a clear picture of what hedging accomplishes. Let’s assume a binary option trading platform that offers 175% payout on an in-the-money expiry, a 15% payout on an out-of-the-money expiry, and a 100% payout on an at-the-money expiry. We’ll imagine an investor with $2000 to spend, looking at trading in Silver.

At the beginning of the contract, Silver is trading at 18.960, and the binary option trader has reason to believe it will increase in value over the next hour, at least to a strong resistance at the 19.000 level. Without hedging, they could purchase a single binary option Call contract for $2000 at 18.960. If the price expires above that level, they will receive $3500, for a profit of $1500. If it expires below that level, they will receive $300, for a loss of $1700. If it expires at that level they will receive $2000, for no net loss or gain.

Now let’s assume instead that they purchase a $1000 Call contract at the 18.960 level. Over the next forty minutes the asset climbs up to 19.000, and it becomes uncertain whether it will hold or rebound. Rather than waiting it out, the investor can instead purchase a binary option Put contract for $1000 at 19.000. Now the number of possible outcomes has increased immensely. If the binary option contract expires at 18.990 they will receive $2750 for a profit of $750. If it manages to rally and break the resistance, they will receive $1900, for a loss of only $100. If it drops down to between 18.960 and 18.990 they will receive $3500 for a profit of $1500. If it drops all the way to 18.960 they will receive $2750 for a profit of $750. And if the bottom falls out and it drops below 18.960 they will receive $1900, for a loss of only $100. What they’ve done is used hedging to make it so their binary option can at the worst only lose them $100 of their $200, at the best still makes them a $1500 profit, and in two cases still earns them $750.

The other way to hedge is to purchase an opposing position on an entirely different asset that is related to the same market. For example, if one purchases a Call contract on a USD-based forex pair, one might at the same time purchase a Put contract on Gold, as these two often move inversely to one another.