There are only two possible outcomes when you trade binary options. Basically, you will either win all or loss all. In addition, the financial markets are volatile environments meaning that the price of an asset can rapidly surge in either direction without any prior warning. One of the worst experiences you can suffer when trading is to watch a profitable trade vanish right before your eyes.
This is why experts deploy hedging which is effectively a method to substantially reduce risk exposure by locking-in profits at every possible opportunity. As such, hedging complies with the famous trading maxim which states to ‘Take care of your losses first and your profits will look after themselves’.
How does hedging work and is it complex? No, it is not as hedging is one of the simplest strategies to execute. There are many ways that hedging can be implemented but let us examine one of the most popular involving a combination of CALL and PUT binary options. The following trade was performed using the 24Option trading platform.
Preference: moderately bearish
PUT option: below $498.51
CALL option: above $507.50
Expiry time: one hour
The price of Apple broke below the $498.51 level at 9.30am EST, as shown on the next chart.
An expiry time at 10.15am EST was selected and a deposit of $100 was chosen supported by a total amount of $5000, as shown above. The payout when in-the-money was 75% while the refund was 0% when out-of-the-money. The reward-to-risk ratio was therefore 75%:100% or 3:4.
Next, the BUY’ button was clicked and the details of the trade were then presented as follows, which could be subsequently monitored in real-time.
About 20 minutes later, the Apple had indeed fallen by over $3 and the trade was now well ‘in-the-money’ as shown in the next chart.
However, as the trade now had an ‘oversold’ status, there existed a strong chance that price could rally sharply. Under volatile conditions, profits could not only be squandered but losses could also still result. Consequently, in order to lock in profits and minimize risks, a hedging strategy was executed by opening a new CALL option based on Apple and pairing it with the original CALL trade, as shown in the next chart.
After selecting an identical deposit and expiry time, the ‘BUY’ button was clicked and the next diagram was produced.
This hedging strategy now provided a window of opportunity between $490.69 and $494.28 within which both options would produce payouts generating a double profit. In addition, any potential loss was almost eliminated as the profits of one option would nullify the loss of the other.
This means that the reward-to-risk ratio was now $150:$25 or 1:6 implying that the payout when in-the-money will be $350 while the total loss if out-of-the-money will be $25.
At 10.15am EST, price finishes within the window of opportunity, as shown in the next chart.
As the trade expired at $490.835, a double profit was recorded returning a total payout of $350 which included the wagered amount of $200, as displayed on the next chart.
As the above example demonstrates, hedging strategies can very effectively help you minimize your risk exposure by locking-in profits. As the financial markets possess such dramatic and volatile environments, hedging is a great tool to help you combat these features and achieve success.