Hedging with binary options can be a powerful tool for managing risk in volatile markets. By simultaneously buying both a put and a call option on the same asset, traders can create a strategy that profits regardless of price direction.
This approach protects your investments, minimizes potential losses, and enhances your trading flexibility.
Key Facts About Using Hedging Strategy With Binary Options
- Hedging with binary options helps you manage risk—by covering both outcomes; you can protect your investments from unexpected market moves.
- You can profit in any direction—whether prices go up or down, hedging can set you up to win either way.
- It’s all about balance—using strategies like the straddle or collar, you can limit losses while still having the chance to earn.
- Great for uncertain times—when markets are unpredictable, hedging with binary options gives you more control and peace of mind.
What It Means To Hedge a Binary Option
Hedging a binary option means buying a put and call on the same financial asset, with strike prices that allow both to be in the money simultaneously. The put option means predicting an asset price will go down within a specific period. In contrast, the call option means predicting an asset will go up within a stipulated time frame.
Therefore, if the price is between the predicted strike prices at expiration, the call and put option will be in the money. This allows traders to profit over their premium whether the asset’s price increases or decreases. Hedging with binary options allows traders to protect their investments and mitigate potential loss by creating a position opposite to the current one ( Put and call options). So, if one position fails, the other position will bring profits. This enables traders to manage risks when price movements are highly unpredictable.
Types of Hedging With Binary Options
Hedging your own binary options trades and hedging your main portfolio with binary options are two effective strategies for managing risks:
Hedging Your Own Binary Options Trades or Portfolio
This requires traders to safeguard certain trades or investments using binary options. An example includes placing a bet that a specific stock price will increase and simultaneously placing another bet that the price will go down.
This hedging strategy enables investors to mitigate potential losses if their original trade does not go as anticipated. Mainly, hedging your own binary options trades focuses on mitigating the risks associated with individual trades and investments.
Hedging Your Main Portfolio With Binary Options
Traders hedging their main portfolio with binary options protect their entire portfolio from risks and price irregularities. Rather than hedge individual trades, they hedge their overall portfolio performance to protect all their assets.
An example is a trader having a diverse portfolio of stocks and bonds. Nevertheless, they purchase binary options that pay off if the entire stock market declines within a certain period. This enables them to offset impending losses in their leading portfolio with profits from the binary options.
This approach is more comprehensive than hedging specific trades with binary options. It allows investors to safeguard their entire portfolio from market risks and volatility. However, choosing the best approach depends on a trader’s investment goals and risk tolerance.
Strategies for Binary Options Hedging
Some prominent techniques for binary options hedging include:
- Straddle Strategy
- Collar Strategy
- Reversal Strategy
- Protective Put Strategy
- Covered Call Strategy
Straddle Strategy
A straddle strategy involves buying a put option and a call option simultaneously for the same security with the same strike price and expiration date. Traders often adopt this strategy when they foresee a significant stock price move but are uncertain whether it would increase or decrease. Hence, they place bets on the negative and positive outcomes.
A straddle provides a trader with two main options for making market predictions about a stock. These include the anticipated market volatility of the security and the expected trading range of the stock based on its expiration date.
If the price of the underlying asset moves in either direction before the expiration date, one of the binary options will generate profit while the other will bring a loss. Nevertheless, this approach allows investors to reduce their losses and experience some risk management.
Collar Strategy
This technique combines options to limit your potential loss and gains of underlying security within a specific timeframe. Investors employ this strategy when they are positive about a stock they own long-term and are concerned about short-term market volatility.
Therefore, a trader owning an underlying asset will create a collar by purchasing a protective put option for the underlying security. The put option enables the investor to sell the asset at a specific price and within a stipulated time frame. It also protects against the price of security going down.
Simultaneously, the investor sells a covered option for the same underlying security. A covered call requires selling a call option while holding a long position in the underlying asset. Selling the call option allows the investor to generate income but control the potential profits on the assets.
In addition, the investor may purchase binary options that pay out if the underlying asset price falls below a specific range or remains at a certain price range. Consequently, these binary options offer extra protection against downside risks and provide additional income to offset the cost of buying a protective put option.
However, the collar strategy limits an underlying security’s potential losses and gains. It allows the trader to make a profit from the security up to the call’s strike price, but not above it. Hence, while it protects against huge losses, it caps potential profits.
Reversal Strategy
This strategy focuses on predicting when a price will change direction. An uptrend reversal happens when an asset’s price stops falling and starts rising, while a downtrend reversal occurs when the price stops rising and begins to fall.
To use this strategy, traders look for signals that a reversal might happen, such as overbuying or overselling, large market orders, or significant news events. When they spot these signals, they enter a binary options trade.
For example, if the market has been declining, a trader might buy a “call” option, expecting prices to go up. At the same time, they might also buy a “put” option in case the market continues to drop or goes back to its previous state. This approach helps manage risks if the market doesn’t reverse as anticipated.
Protective Put Strategy
A put strategy requires a trader to buy a put option, also known as the premium. A put option gives an investor the right, but not the obligation to sell an underlying asset at a specific price and within a specified timeframe. An investor may buy put options if they expect the price of an asset to fall in the long run.
Doing this enables the trader to make a profit if the underlying security falls under the strike price by more than the premium they paid for the put option. Alternatively, an investor may also sell a put option, receiving a premium from the buyer in exchange for the obligation to buy the underlying asset at the strike price.
Example:
Assume you are trading on Gold. Now, you buy two trades for Gold for $200 each. You can use one binary option for a call and the other for a put. So you have two predictions: if the market goes up, you will have a profit, and if the market goes down, you will still make a profit.
Imagine the gold market is trading at $1700, and you predict it will go up. If you’re right, you could make an 80% profit.
Let’s say the gold price hits $1800 the next week. If you bought both a call and a put binary option for $100 each, you’d make $180 from the call but lose $100 on the put, leaving you with an $80 profit.
Covered Call Strategy
A covered call strategy involves owning an underlying security and selling call options on that asset. The investor collects a premium from the buyer when they sell call options. They generate income on the premium sold, which, in return, increases the return on investment on the underlying security.
This guaranteed premium is the main benefit of a covered call technique. If the underlying asset price increases, the premium will raise the overall return on investment. Similarly, it will offset the portion if the price of the underlying security falls.
Pros and Cons of Binary Options Hedging
- Traders can offset potential losses and protect their investments using binary options hedging strategies
- Investors enjoy optimal flexibility with binary options hedging. Rather than close a losing trade, they can hedge their positions and turn potential losses into profits
- Incorporating different hedging techniques allows investors to diversify their portfolios by spreading their risks across different markets
- Traders incur additional costs when they open a hedge position
- While some hedging strategies protect against losses, they also limit profit potential
Conclusion
Hedging is an effective strategy for investors looking to manage their losses in binary options trading. However, before starting, examine its pros and cons to determine the best strategy for your investment objectives. Finally, explore the various hedging strategies available and choose the technique that aligns most with your investment goals and risk appetite.
BREAK
#2 Resistance and support
Now there are other ways of hedging that are based on the concepts of resistance and support.
Firstly, you need to find the range in which the price will move between a particular support and resistance. Then the aim is to open the call and put on the support and resistance. The idea is to hedge your position. If you hold a call at the support price, the price will rise until it reaches your resistance area. You can then sell a put.
This will lock in your profit from the call and put before the options expire. Between the support and resistance, there’s a 99% chance that the cost will close somewhere in the middle of the support and resistance.
When your binary options expire at this point, the price will be lower than your opening price and the amount will be higher than your call opening. So from here you have the first scenario where you can make a double profit with the potential for a guaranteed profit.
Now let’s consider the second scenario; by implementing the same plan, you have to buy a call and a put. However, the support is broken this time, and it is pretty obvious that the support does not hold forever (as explained in the the support and resistance strategy).
This time the support will be broken close to the expiration date, so your call investment will suffer a loss, but at the same time your put investment will gain. So once again you have a guaranteed profit, but with a reduced loss. Whatever the situation, your profit is guaranteed on at least one position.
- → So your loss will be dramatically reduced. However, if you place a call to the support line, you will incur a loss.
Let’s say you placed a $10 call at the lower expiry price. You will now make a loss of $10. If you hedge that point with a $10 put, you will have a $10 loss on your call.
Instead, you could make a profit. Assuming the payout is 70%, you will lose $10 on the call, but at the same time you will make $7 on your put. This way you only lose $3 instead of the 100% amount, which is $10. So let’s move on to the first scenario; you can make a double profit by hedging the position.
Understanding the mechanism of hedging
So there are different ways to approach hedging strategies in binary options. However, hedging is not limited to binary options. The concept of hedging goes much deeper. Advanced investors use the concept of hedging in many financial areas. There is no need to get lost in the complexities of hedging strategies, but knowing the core mechanism is crucial.
Most asked questions about hedging strategy:
Can all investors adopt hedging with binary options?
Hedging with binary options may not be suitable for all investors because it has downsides, like capping potential profits. It’s best to review your risk tolerance and investment goals to determine whether hedging with binary options is best for you.
When should I consider hedging with binary options?
Investors can consider hedging with binary options to protect against market volatility or mitigate risks. To do this, assess their risk tolerance and investment objectives.
Do alternatives to hedging with binary options exist?
Some alternatives to hedging with binary options include traditional options and future contracts. Each strategy has advantages and downsides, so explore options and choose what suits your investment goals.
