Today, we will look at trading forex binary options on the USD/JPY pair (US Dollar / Japanese Yen). A two-minute chart (like the one shown below) is a useful tool when looking to trade 5-minute expiration options. The binary options we will look at in this example were available on March 8th, expiring at 8:30 p.m. EST. These options become available 5 minutes prior to expiration, which in this case was at 8:25 p.m. EST.
Two possible strikes are labeled on the chart, 112.51 and 112.45. The horizontal lines drawn at those levels show the movement of the USD/JPY in the half hour prior to expiration both above and below those strikes. Given the fluctuation of this USD/JPY forex pair during that time period, it seemed reasonable to to expect that price could possibly move 3 pips (“price interest point” – for the yen, this would be in the second decimal place or hundredths place) in a five-minute time period.
Binary options can be traded with any market view, and offer a yes or no proposition as to whether price will be above or below a certain strike at expiration. (Expiration time-frames are offered intra-hourly, hourly, daily and weekly. For this example, we will look at the intra-hourly 5-minute expiration, the shortest expiration timeframe available with binary options).
These binary options are based on a settlement value of $100 per contract. When you buy a binary option at the offer, you will profit on that option if price closes at expiration above the strike offered; in this case, your risk is the purchase price, and your potential profit is the difference between the $100 settlement price and your premium.
When you sell at the bid, it indicates that you believe that price will close below the strike. When selling an option, your profit would be the amount you sold it for, and the risk would be the difference between the $100 settlement and the selling price.
Let’s look at how this works. The image of the strike list shows all of the 5-minute binaries for the USD/JPY available yesterday with an 8:30 p.m. EST expiration. For this example, we have chosen the second and fourth strikes on the list. The basis of entering this trade is the belief that the USD/JPY would continue moving in one direction or another within the next 5 minutes, exceeding the limit of the strikes. If your market view was that price would close above 112.51 at 8:30, you could have bought the USD/JPY 112.51 strike at the offer for $22.25 per contract, which would be your risk. If price settles above the strike level at expiration, your profit would be $77.75 ($100 settlement – $22.25 purchase price).
On the other hand, if you believed price would settle below the strike of 112.45 at 8:30, you could sell the USD/JPY 112.45 strike at the bid of $81.75 per contract. This amount would be your profit if you are successful. Your risk would be $18.25 ($100 settlement – $81.75 selling price).
Both of these trades have the potential to yield about a 4-to-1 reward-to-risk ratio – you risk around $20 to make around $80 per contract, in just 5 minutes. The risk if very clearly defined. With each binary option, you know the exact amount you are risking going into the trade, and there are no margin calls as with traditional futures trading. Binary trades may also be exited at any time prior to expiration if desired; and binaries can be entered for lower dollar amounts than outright futures trades, further limiting risk.
Binaries meet meet the demands of modern trading in creative ways, and they are flexible due to the variety of expirations, instruments and strike prices offered. This trade shows examples of trading single binaries; you can also combine a trade with two binaries to form a straddle or spread, making trades with any market viewpoint possible.
Note: Exchange fees are not included in calculations.