USD/JPY: Trade Forex Pairs Without Forex Risk
The largest market in the world is the trade in currency exchange rates. In late 2015, the Japanese Yen was trading around ¥120 to one dollar US, or about 80 cents to 100 yen. The yen has been in a multi-year downtrend, but on this day, you see the yen dropping from 123.4 the evening before to under 123 today.
Every binary option trade has four basic steps:
- Choose a market to trade and the time frame you want to trade
- Choose a strike price you think the market will be above or below at expiration (or before)
- Buy or sell for an amount you are willing to risk
- Manage the trade until exit or expiration
The Nadex USD/JPY binary option is based on the spot USD/JPY exchange rate.
1. Choose your market, buy or sell direction, and expiration
You see that the market fell then rose, stopping at a resistance level around 123.00 yen. It has come down from that level and you think the trend will continue through the afternoon.
That means you also want to select a contract with the right expiration, one that allows your trade enough time to develop through the afternoon, but doesn’t require you to pay for extra time that you won’t use.
You decide to sell a binary option, which will profit if the market expires at or below the strike price you choose. So your first step is to choose a strike price.
2. Strike price: your line in the sand
The basic question a binary option is based on is, will the market be above this line at this time? Since you are selling the binary option, now it’s time to choose the line you think the market will be at or below at expiration (preferably well below).
While some traders will choose their strike price from the contract list, many of you may prefer to open a chart overlay comparing the strike levels which the binary ladder charts displays. Each of strike levels have buy and sell buttons with the appropriate binary pricing to place your order right from the chart window.
You decide that the market is likely to continue dropping for another hour or so, but you can’t be as sure about any longer. So you sell the contract
USD/JPY >123.00 (3PM)
3. Complete your order ticket and place your order
You sell at the bid price, which is fluctuating around 39.00 at the time. You are filled at 38.75.
That makes your maximum loss $100 minus $38.75 or $61.25 per binary option contract in your order.
Your maximum profit is $38.75 per contract.
Since the market is already below the strike price (which is where you want it to stay), you pay for that edge. That’s why you take on more risk ($61.25) than the buyer, who pays $38.75.
You pay $1 per contract in fees to enter the trade, up to a maximum of $50 for 50 or more contracts. If your order is more than 50 contracts, you pay no additional fees.
If you want to enter the order at a different price level or quantity you can adjust using the up/down arrow keys within the tab space. At the bottom of the order ticket, you’ll see your maximum profit and loss (initial trade cost), associated with that binary price if you place the order. It is always a good habit to run through the check list below before placing your order.
- Do you have the right expiration and strike price?
- Are you buying or selling?
- Did you enter the correct number of contracts and the price you want to pay?
- Does your binary price reflect the profit /loss ratio you’re looking for?
After you click Place Order, the trade will either be filled right away, giving you an open position, or it will sit in the Working Orders window. Once it is filled, it will move to the Open Positions window.
Binary prices can move fast, so keep an eye on the live quotes. If they move away from your order price, you will probably not get filled right away.
At this point you can decide to wait until expiration or watch the trade develop and decide whether or not to take an early exit. Successful traders know, at this point it’s important to have a plan.
You’ll find that knowing your maximum loss and profit up front allows you to plan and execute with more confidence. The max profit gives you a definite target. And the max loss often helps reduce the anxiety of risk-taking and lets you make wise decisions.
The trade quickly becomes profitable as the market drops. Do you get out with a $7.25 profit or wait? These are the decisions every trader makes. This is where it helps to have a plan.
4. Manage your trade until exit or expiration
As a seller, you will end up with one of these three outcomes:
If the USD/JPY is back above 123.00 at expiration, then you will receive $0, meaning you don’t get back any of the $61.25 you paid to enter the trade. You pay no settlement fee if your option expires at $0.
If the USD/JPY is at or below 123.00 at expiration, you will receive the full $100. You get back the $61.25 you paid and keep the remaining $38.75 as profit. You'll pay a $1 settlement fee if your binary expires in the money (at or below 123.00).
Exit before expiration
You can exit before the binary option expires, either to take profits or cut your losses. Either way the math is the same: your profit or loss will be the difference between the price you paid and the price at which you exit. You'll pay a $1 trading fee if you exit before expiration.
If you exit before expiration with a loss, that loss will be less than $61.25. If you exit with a profit, that profit cannot be above $38.75. Everything happens within that range with a binary option. This is a different risk/reward profile than you’d have trading the USD/JPY with a forex broker.
In this real world example, the USD/JPY continued downwards, further from the strike price. This is good news for a seller like you. In less than an hour, the offer price (at which you would exit) is hovering around $10. You decide to get out with the substantial profit at hand rather than wait for expiration.
You get out at $8, for a profit of $30.75 per contract in under an hour.
While you would get more at expiration, a lot could happen in the remaining time, including an upward retracement. You’d rather not take the risk and end up handing back the profits you have. See how the decisions you make are the same you’d make trading forex, but the risk parameters are more clearly defined?
For forex traders or those who want to get into forex for the first time, binary options may be a better way to trade a market you already know.