No matter how safe you play, investing in the markets always involves some degree of risk. But what if you could reduce that risk to an almost negligible level and protect your profits? Well, that’s when you ‘hedge your beats’.
Hedging strategies are the phenomenon of exposing both call and put options on the same financial instrument to avoid huge losses due to unpredictable market changes. Sounds complex to understand? Stay with the article and consider the simplification.
Most important facts about the hedging strategy in binary options trading:
- Hedging with binary options entails purchasing call and put options concurrently, aiming to diversify investment risk rather than significantly reduce it.
- Accurate market predictions may yield profits ranging from 60-80%, but incorrect ones could result in the loss of the entire stake; hedging seeks to balance potential losses.
- In hedging, traders acquire both types of options on the same asset, which could lead to gains if the market moves distinctly, but net profit is not guaranteed due to the cost of both options.
- Traders utilize support and resistance levels to inform their decisions on when to place call and put options as a hedge, with the goal of securing a profit, although market unpredictability can affect outcomes before the options expire.
What you will read in this Post
What is Binary Options hedging strategy
As the name “hedging” implies, this strategy in binary options is about protecting your investment from a potential loss by opening a position opposite to your current one. Unlike other strategies that focus on maximising profits by predicting price movements, hedging aims to mitigate potential losses.
It’s like taking out insurance on your trades; if one position fails, the other will profit, effectively offsetting the potential financial impact. The main reason traders use this strategy is to manage risk, especially in volatile markets where price movements can be unpredictable. By hedging a position, a trader can ensure that even if the market moves against his original trade, the loss can be offset by the profit from the hedged trade.
Why do you need hedging for Binary Options trading?
The concept of Binary opinion trading is based on a single question “Will the market end up going up or down from a certain price point under a defined time period?” In short, spectating the future market profit or loss by a certain time.
If the result on binary options is correct according to your prediction, then you get a profit of 60% to 80% along with your invested money. On the other hand, if the market goes against your prediction, you lose 100% of your investment.
Let us understand this with an example to make things easy.
Let’s say you are a trader and do binary options trading. Now, for the last one month, you are observing the change in the price of petrol.
After implying your strategies and reading the graph, your mind concludes that next week the petrol market will go above $1500. So, by keeping it in mind, you invest $100 with the expectation that next week the petrol market will be above $1500.
After one week you see that the petrol market has gone up to $1550, so your prediction is correct. Now here you will get a fixed amount of profit of 60%. So your $100 will convert to $160 when you get the profit.
If this situation is looked at in the reverse condition, assume that the market has gone against your prediction. For example, you had estimated that the petrol market would cross $1500, but for some reason, it comes down to $1400.
In such a situation, you lose all the money that you put on this trade. So even if the market has only changed 10%, you would lose 100% of your investment.
The loss is a huge burnout! But what if, in these circumstances, you can find a technique by which you can make your return chances equal to the nominal?
That’s the point when you need ‘Hedging Strategies’ for your trades.
What is Binary Options hedging?
Hedging is a strategy that traders implement to avoid the risk of loss in investment. It’s like buying insurance for your investment to bring down the loss burnouts.
Let’s try to connect it with an example from our everyday life.
Whenever you purchase a new car, you also go for an insurance policy for that vehicle. So that if there is an accident of that vehicle in future, then you can recover the amount. Just as security, you invest money in two places.
The same rule goes for hedging in binary options. Again, your money is invested in two places so that even if your prediction goes wrong due to some reason, you can still recover the lost money.
Now let’s dive into the exact strategies of hedging.
Binary Option hedging strategies
In simple words, you have to buy two binary options for the same instrument. One option for the call (raise of market price from initial value) and the other for put (down the market price from initial value).
#1 Using Put and Call together
For simplification, assume you are trading on Gold. Now, you buy two trades for Gold for $200 each. You can use one binary option for a call and the other for a put. So you have two predictions: if the market goes up, you will have profit, and if the market goes down, you will still make a profit.
Let’s assume that the gold market is currently trading at $1700, and if the prediction is correct, you will make an 80% profit.
Next week the gold market reaches $1800. When you have bought both the call and put binary options for $100, you will have $180 in profit. Overall you will have a $180 profit on the call and $100 in loss under the put. So you will get $180 – $100 = $80 profit.
By doing binary options trading in this way, you greatly reduce your chances of losing. The only problem here is that not every broker provides the facility of hedging on the instrument.
Make sure to pin the point that you can purchase a call as well as a put for the identical financial instrument on a similar strike cost, but they won’t be hedged. Hence, they will move in a reciprocal direction resulting in money loss by using binary options.
#2 Resistance and support
Now there are other paths to perform hedging that rely on the concepts of Resistance & Support.
Firstly, you have to find the range for price moving between a particular support resistance. Then, the goal is to open the call and put on the support and resistance. The idea behind this is to hedge your position. If you keep a call on the support cost, it will move towards the up direction reaching your resistance area. After that, you can sell a put.
By doing so, you secure your profit from the call and put before the options expire. Till the support and the resistance occurs, it’s said that there are 99 percent chances of the cost being shut somewhere mid of the support and resistance.
If your binary options expire at that point, the price will be lower than your opening output, and the amount will be higher from your call opening. So from here, you have the first scenario where you can gain double profit with the potential to have a guaranteed win.
Now let’s consider the second scenario; by implementing the same plan, you have to buy a call and a put. However, the support is broken this time, and it is pretty obvious that the support does not hold forever.
This time, the support will be broken near the expiry so that your call investment will suffer a loss, but at the same time, your put will gain profit. So once again, you have a guaranteed win but with reduced loss. Regardless of the situation, your win is guaranteed for at least one position.
Hence, there will be a dramatic reduction in your loss. However, if you place a call on the support line, you will make a loss.
Let’s say you have placed a $10 call price to the lower on expiry. Now you will make a $10 loss. If you hedge over that point with a $10 put, you will have a $10 loss on your call.
Instead, you can make a profit. Assuming the payouts are 70%, you will lose $10 on-call, but at the same time, you will gain $7 on your put amount. This way, you will lose only $3 instead of the 100% amount, which is $10. So let’s move to the first scenario; you can have a double profit if you hedge the position.
Understanding the mechanism of hedging
So there are different ways to approach the strategies of hedging under binary options. However, hedging is not bound to binary options. The concept of hedging goes way deeper than binary options.
Advanced investors use the concept of heading in many financial fields. There is no need to jumble in the complexity of hedging strategies but knowing the core mechanism is crucial.
Let us take an example to understand this more thoroughly. Suppose you are an investor and you want to buy shares of a company named ABC of your own free will. Now the price of a binary call of that company is around $20. Therefore, to buy one share of that company, you have to pay $10.
Under the hedging strategy, you buy a binary call and a binary put option. As mentioned earlier, the binary call price is $20, and one share of ABC company is $10. So under this, it is found that the total value of the binary call is equivalent to one share of the company.
Now it comes out that the strike price of Company ABC is the same as the binary put, which is equal to $10. So in simple lines, you as an investor will immediately make money.
It is because you purchased the binary option at the point where the strike cost of elemental options was below the cost of hedged options.
In this article, it has already been told to you that whenever you buy a binary option, you own the rights to buy a financial instrument at a particular price.
Similarly, if you look at another option, suppose you are an investor and want to buy shares of a company DEF. Again the price of 1 share of this company is $10. So if you buy a binary call at the strike price of $10, you can again make a profit of $10.
Although the binary put strike price here is $20, the old strategy will not work this time. You, as an investor, can gain profit on a put if the cost of that financial device drives down. Now, the strike cost is greater than the cost of the invested device when the option expires.
So, you buy a binary put whose strike price is $10. When the binary put expires, you have every right to buy one share of the company DEF for $10. When you sell a binary put strike which is $10, and the price of 1 share of the company is also $10.
Then it means that one share of the company is exactly equal to the put’s strike price. So now you have the right to sell the company’s shares, you as an investor will earn a profit if the cost of shares of the company DEF is greater than $10 at the time of expiry of the binary put.
Under this example, you need to keep in mind that you initially bought the put at a strike rate of $10. Then, when the investor wants to fence the put with the strike rate of $10, you wish to purchase the call with a strike cost of $10.
Advantages of Binary Options hedging
#1 Hedging is a low-risk game
The fact of placing multiple trades for a particular asset makes it a lower risk game. When you place both, call and put (opposite bets) for any option, they don’t lose 100% of the amount. However, the profit is less but it never tends to 0.
#2 Offers better trading conditions
Hedging is an easy game, but only if you are a pro or someone with experience. For the one who has just entered binary options trading, you should know that scamming is quite frequent in the field. Therefore, finding a genuine site is the first and most vital step in trading.
#3 Pro tip for Binary Option trading
If you have noticed the price graph at the lower side for at least half a year or one year- it’s a symbol of stable price growth. Instead, if you notice frequent downfall of the price, that’s the best time to invest. However, if you notice an increase in price for a long time, it’s simple for you to predict price movement.
(Risk warning: Your capital can be at risk)
Conclusion – Use hedging strategies to trade successfully
In summary, hedging in binary options trading is not just a tactic, but a critical approach for managing financial risks and enhancing profit potential. By employing the right hedging strategies, traders can navigate the volatile landscape of binary options with greater confidence and control. These strategies enable traders to balance their positions, safeguarding against unpredictable market movements. As a result, hedging becomes an indispensable part of a trader’s toolkit, offering a pathway to more stable and predictable financial outcomes. Ultimately, understanding and applying these strategies is key to achieving success in the complex world of binary options trading.
Frequently asked questions about hedging in binary options trading:
What is the primary purpose of hedging in financial trading?
The primary purpose of hedging in financial trading is to secure consistent profits and reduce the risk of substantial losses.
How does hedging benefit binary options trading?
Hedging benefits binary options trading by providing a strategy to manage financial risks and potentially increase profit margins.
Can hedging strategies guarantee a win in binary options trading?
While hedging strategies can significantly improve the chances of profit, they do not guarantee a win due to the inherent risks and unpredictability of financial markets.
Is it essential for traders to understand hedging strategies?
Yes, it is essential for traders to understand and apply hedging strategies to navigate the complexities of binary options trading effectively.