Hedging

Binary Options Trading – Hedging

It should pretty much go without saying that binary options traders have two very basic goals: to earn maximum profits while incurring minimum risks. There are several strategies that help traders meet these goals, and one of the most effective is known as "hedging."

Hedging is a method that counterbalances what appears to be an unsuccessful trade and helps minimize the trader's loss. For example, imagine that the price of oil was dropping consistently and a technical analysis indicated that it was like to continue falling. So, at 11:05 GMT, a trader placed a $100 Put option on the asset, set to expire at 11:30. About 10 minutes before the expiry time, the asset price unexpectedly begins to rise, and continues to do so for 2-3 minutes. It becomes increasingly clear that the Put option will be an unsuccessful trade, and the trader does not wish to lose $100, so he may choose to hedge his trade, and invest now in a Call option on the same asset.

The trader has a couple of options at this point. If he hedges his $100 Put option with a $100 Call option with a 80% payout. He might lose $100 while at the same time earning $80. It is still a loss, but losing $20 is far preferable to losing $100. If the trader is completely confident in the hedge investment, he may even invest more than the initial Put option. The profit would be minimal, but again – preferable to the loss he would have suffered without the hedge.

On the other hand, there is also a risk in hedging. In the example above, say the trader placed his $100 Put option on oil when the asset price was 42.50. When the price hit 44, the trader opted to hedge his loss, and he placed another $100, this time on a call option. If the price closes above $44 at the expiry time, then he has hedged his loss. But if it drops again and closes below 44 but above 42.50, then the trader has lost both trades.

However, it is also possible to hedge a loss, and earn a double profit. Imagine a trader has placed a $100 Call option on Apple when the stock price was $120. The price rises to $130, and the trader is feeling very confident about his trade, until suddenly the price starts to fall. When it hits $123, the trader places a second trade, this time on a Put option. If the price continues to drop, but closes at $122, which is higher than when the initial trade was made, then both the Call at $120 and the Put at $123 are successful trades, and the trader has profited on both.

While the examples above used standard binary options trading for illustration, in general the strategy is most effective with long-term trades. That is when, as a trader, you have the luxury of watching and thoroughly analyzing how the market in general, or an asset in particular, are moving. Many traders will use either standard, or even short-term trades to hedge long-term trades.

Hedging is most effective when the trader carefully watches what is happening in the market, even (or especially) after he has purchased a Call or Put option. Traders who like to place their trades, and then simply wait for the results may do very well in trading binary options, but cannot effectively hedge any pending losses.

Hedging is also an excellent strategy when combined with traditional trading of forex or stocks. A trader who has purchased shares in a company whose stock value is rapidly falling, can hedge his stock market losses with a Put option on binary options on that same asset.

Although, hedging is considered an "advanced" strategy, it can also be an excellent learning tool for novice traders, provided they keep their investments modest. Experienced traders can use their understanding of technical analysis in order to most accurately determine when an asset price is likely to either change direction, or continue on its set path, and that knowledge is critical in hedging a potentially unsuccessful trade. Beginning traders can use hedging as a way to learn both market trends and methods of analysis, and hopefully offset some of the expected unsuccessful trades while learning through experience.