Forex Binary Options Hedging Strategy For Spot Trades!
You can bet on the direction of the currency market with the help of forex binary options Forex Binary Options also known as Exotics give you a fixed payoff of $100 if the market is above or below a certain price level when the binary options contract expires. And in case the market does not cooperate, you get $0 as a payoff. You can trade forex binary options on currency pairs like EURUSD, USDCAD, GBPUSD, USDJPY with intraday, daily and weekly expirations.
Forex Binary Options come with half hourly, hourly, daily, weekly and monthly expirations. You can trade them in many ways. But here we are going to show you a unique way in which you can use them to hedge your spot positions. This forex binary options strategy can be used to reduce your risk further in the spot market. Suppose, you want to trade the EURUSD pair. It is in an uptrend. You take a long position on EURUSD when the exchange rate is 1.2567 and place the stop loss 30 pips below your entry. Suppose, you are trading on the daily charts!
This means in case the exchange rate fluctuates to 1.2537, the stop loss will be triggered and you will be out of the market with a loss of 30 pips or $300 on a standard lot of $100K. You are expecting the market to go up! But it is always a good strategy to hedge your spot position. You have already placed the stop loss to reduce risk. You can use forex binary options to further reduce your risk.
Buy five forex binary options with expiry of 24 hours and with strike or expiry price less than 1.2537. Suppose, the cost of each contract is $20. So, you total cost of creating this hedge is $100. Now, if the market does go down below 1.2537 in the next 24 hours, you will make a payoff of $100 on each contract or a total of $500 on the five contracts. Deducting the cost of buying these five contracts, your net profit will be $400.
Now, in case your spot trades develops as you had planned, you lose $100 that you had invested in creating the hedge with the forex binary options. But this is a small premium that you had to pay just like the auto insurance premium that you pay to insure your car. Suppose, next day, you are already up in profit by 30 pips so your cost of creating the hedge is already covered. But suppose, you lose 30 pips and the EURUSD exchange rate ends up below 1.2537. Your payoff on the five forex binary options contracts will be $400 minus the $300 you lost when the stop loss was triggered giving you a payoff of $100 when the market had moved against you!
This forex binary options strategy can be used in hedging your position in day trading, scalping and swing trading. Sometimes, traders are reluctant to enter into a trade with a stop loss of 30-40 pips or more even when there is a good risk to reward ratio. Using this forex binary options strategy you can hedge your spot positions and lower the risk even more making you comfortable in using a 30-40 pips stop loss.
Article Source: FxTradingStock.com
About the Author
Mr. Ahmad Hassam has done Masters from Harvard University. Try these Forex Signals by two top gun traders in a friendly competition. Discover these Forex Binary Options Systems that can give a return as high as 400% in just 1 day.
by: Ahmad Hassam
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Word Count: 534
Date: Tue, 23 Nov 2010
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