The Binary Options Straddle Hedging Strategy
The Straddle Hedging Strategy Explained
The Straddle, often referred to as hedging is a popular strategy used by investors with some varying degrees of experience, although experienced traders use hedging in binary options to make substantial profits whilst ensuring that the risk involved in their investments is as low as can be.
Straddle Hedging Strategy
How does it work?
In its essences, it involves purchasing a Call Option and a Put Option on a singular asset. The idea being that the investor straddles the asset as close as possible to its highest and lowest points. A call option is places when an asset is lowest price and when the asset’s price increases, a Put Option is placed. The best situation is if at the time of expiry the price settles between these 2 strike prices the investor has set, then both the investor’s options will be in-the-money and maximizing the profit. In the worst case situation, the investors will get the payout of at least one prediction in the money, meaning that they have reduced their losses whilst maximized their gains. Taking a solitary binary option will result in losing all the investment if it closed out of the money. However, with the straddle strategy, one of the options will still be in the money regardless, reducing the loss.
To give the strategy its greatest chance of success, this strategy requires the close observing of the movement in the asset to decide when it seems to have peaked in both of the directions. The Call Option and Put Option do not have to be purchased at the same time, instead an initial Call Option or Put Option can be purchased with a longer expiry and the second Call Option or Put Option purchased once the direction of the asset is more established. The decision when to make a call and put option usually depends on the current trading factors and whether or not they are going according to a trader’s prediction.
Hedging Example
For example, a $500 Call option is purchased on Corn at the strike price of 5.1 with an hourly expiry. If the asset is closely watched throughout the hour and its price is increasing but appears as though it may have reached its peak, then a Put option could be purchased at the strike price of 5.3 for $500 with the same expiry.
If at time of expiry the price of corn expires in between 5.1 and 5.3 then the investor has received payouts twice. If the return rate was 70% on both options then the investor may make $680. The following situations may happen:
The Corn price may expire at 5.1 or 5.3 exactly; meaning both the call and put options to both is at-the-money. The investor will get $850 for the two trades. Total investment= $1000. Profit= $700. (-500 + 850 + -500 + 850) The result will be a net gain.
The Corn price may expire lower than 5.1, meaning the call option out-of-the-money. Therefore the investor will get $75 in return of the amount initially invested. When this happens the put option will be in-the-money, and the investor will get $850 of their amount initially investment. Total investment = $1000. Profit= – $75. (-$500 + $75 + -$500 + $850) The result will be a net loss; however the investor will still lose a lower amount than in other situations
The Corn price may expire above 5.3, meaning the call option at-the-money, and the investor will get $850 in return of the amount initially invested. When this happens the put option will be out-of-the-money, and the investor will get $75 in return of their amount initially investment. Total investment = $1000. Profit = -$75. (-$500 + $850 + -$500 + $75) This trade will result in a net loss, but the investor will still lose far less than they stand to gain in other situations.
By using the straddle technique an investor stands to gain a much larger profit via hedging, or meaning two investments in directional opposites, instead of an all-or-nothing outcome of a single binary investment. Where the investors look likely to lose money, they reduce those losses.
Take note that the Straddle Hedging strategy still requires close monitoring of the asset movements. To further enhance this trading strategy, it is recommended that you use this strategy in conjunction with technical analysis.