Using Forex Binary Options To Hedge Your Position In The Spot Market

Using Forex Binary Options To Hedge Your Position In The Spot Market

You can bet on the direction of the currency market with the help of forex binary options. Forex Binary Options are also known as Exotics. These contracts give you a fixed payoff of $100 if the market is above or below a certain price level on the expiry of these binary options contracts. 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.The most popular forex binary options are the hourly and half hourly forex binary options. Forex Binary Options can be used in hedging your spot positions in the forex market. Let's illustrate this with an example. Suppose, you are trading EURUSD pair on the daily charts. You go long at 1.2567 with a stop loss of 30 pips hoping that the uptrend will continue for the next few days. You are expecting to make some nice pips.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!So, you decide to use forex binary options to hedge your position in the spot market. Your stop loss order will be triggered at 1.2537. Suppose it is 11:00 AM. You buy 5 forex binary options contracts on EURUSD with strike less than 1.2537 for a premium of $20. This contract will expire next day at exactly 11:00 AM. Now,if the exchange rate ended up lower than 1.2537, you will get $100 per contract and if it doesn't, you will lose your $20. In other words, you make $500 if the EURUSD rate expires below 1.2537 next day at 11:00 AM and you make nothing if it expires above 1.2537 next day at 11:00 AM. You total cost for creating the hedge is $100 or 10 pips if you are trading a standard lot of $100K.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.

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