Using Binary Options as a Hedge

The beauty of binary options is that there are so many ways to trade them and so many potential benefits from using them. The first and most obvious is to make directional plays on the market of your choosing in a controlled risk environment.

Every time you trade a binary option you know precisely what you stand to gain and what you are risking. In a sense it is a training regimen for traders.

Most experts will tell you that to be successful in trading you must define how much you are willing to risk for what you expect to gain before placing a trade and have the discipline to follow through. That discipline is built into binary options as each contract defines the risk/reward embedded in it. This is no small benefit, as many experts will tell you that this is easier said than done.

Whether you grow to trade more complex strategies using binaries or trade listed futures and options, the discipline of beginning every trade with a defined risk/reward will serve you forever. As you grow as a trader you will find risk management becomes more complex and binaries can play a role in that as well.

If you are trading outright futures a common risk management technique is the use of stops. However, stops can be imperfect for a number of reasons. In volatile markets stop prices can be missed and you can end up being filled at a much worse price causing slippage that blows up your risk model.

Also, temporary spikes can occur initiating your stop before the market resumes in your favor.

Of course, you would be stopped out at a loss and not get the benefit of your correct market call. This often occurs on days there is an economic report. On such days it makes sense to have wide stops in the market and use binaries to hedge your position by taking an opposing view in the market with binaries.

If that typical whipsaw action occurs on a number you can offset losses with binaries and maintain the opportunity of your original position. If you are long S&Ps, you can sell an economic equivalent number of binaries based on a specific price level you do not want to see the underlying market fall below prior to the announcement. Basically you are taking your risk off of the table for a specific time frame.

In the coming weeks we will provide specific examples, as well as cover how to use the North American Derivatives Exchange (Nadex) to take outright positions and to hedge risk. 

Nadex is the first and largest regulated, retail focused, online binary options exchange in the United States.

 

 

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