Risk hedging (hedge means insurance, assurance) is one of the binary options trading strategies. This strategy allows minimizing trading risks from the former incorrect decision and includes reduction of the potential profit. In addition, this method allows correcting mistakes, which were caused by the incorrect decision on buying the certain option. This one method is one of the most widespread methods of the money management.
Binary options hedging strategies: example
For example, you buy the Call option with tool EURUSD, strike-price 1.3600, and value $100 at 10-00 and it has the expiration time in the end of a day (at 24-00). Payment in case of success (if the price will be higher than 1.3600 on any value up to the midnight) will be 170% or $170. Otherwise, you will get the repayment in the amount of 15% or $15. The price of EURUSD has reached 1.3700 at 17-30.
If you assume that the further movement will change in the reverse direction, then it is the time for the purchase of the Put option with the same value and expiration time at the new strike-price (1.3570). By doing so, we set the range in which, as we assume, the price will move. This exact action is called hedging of the single currency pair.
Eventually, there are three possible outcomes at 24-00:
- The price of EURUSD is lower than 1.3600. In this case, the first Call option loses and the second wins. Total repayment amount will be $185. And you have invested only $200. Eventually, your loss from two operations will be only $15 instead of $85.
- The price of EURUSD is between 1.3600 and 1.3700. Both options turned out to be successful. Total repayment amount will be $140. Eventually, your clear profit is $140!
- The price of EURUSD continued to grow and became higher than 1.3700 up to the time of the expiration. The first Call option has won, the second has lost. Total repayment amount will be $185. You have invested $200. Eventually, clear loss from both operations is $15 instead of $85.
Binary options hedging strategies: explanation
As you can see, two variants can bring a loss and only one can bring a profit. But let’s review this situation in another way. Before every deal, you have to view the market’s behavior and not conclude deals when it is inappropriate. Buying the second option is necessary if the eventual price has reached the certain support/resistance level or if the sudden change was caused the certain event or the issuance of news. In the majority of cases, the price adjustment in the reverse direction is observed in such situations. For this reason, in this situation you will be able to make profit and instead of losses more frequently.
We also can make risk hedging by opening an option on the asset that is different from the primary and that is used for the conduction of the hedged deal. There is a great amount of assets, prices of which are moving simultaneously or in the reverse directions. In other words, if you have bought the Call option on the tool EURUSD, you can reduce risks by buying the Put option USDCHF because these pairs are moving fairly simultaneously. There is also a number of cooperating and competitive companies whose stock’s prices move either in the same direction or in the reverse directions.
So, if you hedge risks when it is required by the market or when you have made a mistake, you can minimize possible losses or increase your profit substantially. And the profit will be almost 10 times higher than the possible loss.