Binary Option Trading Strategy – Direction Neutral

ForexNewsNow | Published on September 3, 2013 at 8:17 am

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ForexNewsNow – Exchange traded binary options offer traders opportunities to utilize a multitude of strategies for different market conditions. This article will take a look at one of these strategies in which the trader does not need to predict a market direction, they just expect the underlying market to make a sizeable move either up or down.

For this hypothetical example, let’s say that the Bureau of Labor Statistics is releasing Non-farm payroll report in the next hour. A surprise is expected which could push the e-Mini S&P 500 futures contract, currently trading at 1600.00 dramatically, we just don’t know which direction. A trader could look at trading the outright futures contract; however, the overall risk may be tough to define and if using stops, a trader could fall victim on market noise prior to the report even being released. In this case, they may look to Nadex binary options in order to find opportunity to potentially profit while keeping their risk absolutely limited. Additionally, since Nadex lists multiple strike levels on each contract, traders can find precise levels and risk/reward ratios to execute their trades.

With the e-mini S&P 500 futures trading at 1600.00 let’s assume we think the underlying futures contract could move 15 points or greater, in either direction following the report. In this case a trader may look to the Nadex US 500 binary option contract which price is derived from the futures contract. For this example we will look to two strike prices, both 15 points from the current price. When looking at the list of available binary prices we notice the US 500 1615.00 strike trading at an offer of 13.00 and the 1585.00 strike trading at a bid of 87.00 and decides to take the trade.

The entry set-up may look something like this: (All examples not inclusive of exchange fees)

  • Buy 1 contract US 500 > 1615.00 @ 4:15 PM at a price of $13.00
    • $13.00 risk per contract, potential payout of $87.00 per contract
  • Sell 1 contract US 500 > 1585.00 @ 4:15 PM at a price of $87.00
    • $13.00 risk per contract, potential payout of $87.00 per contract
  • The overall position risk on this trade is $26.00 ($13.00 each side)

At this point, the trader could walk away and hope that the market moves and one-side of this trade proves correct; however, because we are expecting a quick move, which can always reverse, we may consider setting limit orders to capture profit in that advent of a quick move that we would not be able to manually execute which may look like this:

  • Sell 1 contract US 500 > 1615.00 @ 4:15 PM at a price of $55.00 with the aim of locking in $32.00 profit on this leg
  • Buy 1 contract US 500 > 1585.00 @ 4:15 PM at a price of $45.00 with the aim of locking in $32.00 profit on this leg
  • Keep in mind every trade and market are different, so these levels are merely examples

Let’s look at a few different scenarios following the release of the Non-farm payroll report:

  • No surprise in the report and the market barely budges. Neither limit order is hit so we have a couple of options:
    • Hang on to both positions and wait and see if there is a later move with the knowledge the most at risk is $26.00 for the entire two-legs of the trade
    • Decide that it was just a dud report and since there is likely still time value in both binaries, close out both legs for a smaller loss
  • The underlying market moves to 1615.00 or 1585.00 filling one of our limit orders at $55.00 or $45.00, respectively (keep in mind there are no guarantees of fills at these levels, this is simply a hypothetical scenario)
    • If one side is filled at limit, the net result would be a gain of $32.00 on one side, with a loss of $13.00 on the other for a net of $19.00 or about 1.5 to 1 reward to risk result on the trade.
  • Another scenario outcome could be a large whipsaw which sees the underlying market move to 1615.00 and then swing back to 1585.00 filling both sides (because binaries do not require a stop and are time bound, both sides remain active until they are closed or expire).
    • In this scenario we may get filled on both sides of the trade for a gain of $32.00 each for a net of $64.00, again, not inclusive of exchange fees. This would be a return of about 2.5 times our original risk.

For more information on benefits of binary options or in-depth information on this strategy, please read “Using Binaries to Trade Volatility” .




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