Trade the short side while limiting risk and without using a stop loss.
The price of crude oil goes up and down in response to a variety of factors: supply and demand, political unrest, and seasonal trends. When oil prices move, other markets often move with them, including precious metals and stocks.
Most stock investors just have to ride it out when a drop in crude prices hurts their portfolios. Other traders welcome the chance to short crude oil, but not everyone wants to take on the level of risk that futures trading entails, not to mention the high account balance and margin requirements.
Nevertheless, half the movement in any market is downward, which means that much potential profit is to be found on the short side. Markets go up and down, so why shouldn’t you have the chance to profit both ways? Binary options give you a limited-risk way to learn and execute short selling in any market, including volatile markets like crude oil.
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 Crude Oil binary option is based on the NYMEX® Crude Oil Futures contract. For this example, let’s say it’s trading around $48.50 a barrel.
1. Choose your market and expiration
You see that crude oil has been in a downtrend for three straight days and you think it will continue. You want to sell a binary option and then either buy it back at a lower price or hold it until expiration.
In the Finder panel on the left side, you choose Commodities (Binaries) and under it, Crude Oil and Daily (2:30PM). You decide to trade a daily binary, which will expire at 2:30PM EST.
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.
Your market bias of Crude Oil is that you’re looking for a trade target of XXX by the end of the trading session which is 2:30pm ET. Assume you decide to choose the binary strike which is the closest to the current underlying crude price. Remember for the binary seller to receive the settlement payout, the expiration price can equal or be lower than the strike level.
Crude Oil (Sep) > 48.50 (2:30PM)
3. Place your order
By clicking on the Sell button of the 48.50 binary strike level, an order ticket will automatically pop up. The order ticket will display the bid price but the number of contracts you wish to sell will still need input where we chose 1 contract.
Note within the order ticket will show updated live bid/ offer binary pricing. A great feature of Nadex ladder charts is that you can see the live chart along with the order ticket. In this case, we might have waited for a better price, when we saw the price ticking back upward:
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.
Back to our example. Crude oil futures drop 20 cents in less than ten minutes. Now you have to make a decision, exit now at a profit or hold to expiration?
4. Manage your trade until exit or expiration
You decide to get out while you have a healthy profit. Sure, the market could go down further and give you the full $44.25 profit (minus $1.80 fee) at expiration. But it could also turn around and take back the profits it is offering you.
Taking profits early on a daily binary can also be a good strategy if you can’t watch the market all day.
Since you sold the binary option, exiting is as simple as clicking the Buy button next to your strike price on the chart. The price when you click is $40.75, a profit of $15 – 1.80 = $13.20 per contract. Not bad for less than 20 minutes’ work.
If the trade had gone against you, you could have limited your losses as well. Your maximum loss was predetermined: $55.75 plus $0.90 to enter the trade. But you could have exited with a smaller loss the same way you just took profits, with two clicks.
As you can see, we designed the Nadex Trader platform and our other platforms to support you but not get in your way. The challenging part of this trade was the part we think traders should focus on: planning your entry and exit strategy, and executing it with patience and discipline.
At no time did worry about how much you might lose, since you knew that up front. And at no time did you wonder if the pricing was reliable, or if the exchange might be taking the other side of your trade, or if your fill was really the best possible one. And finally, the platform itself didn’t get in your way.
Without those distractions, you were free to focus on the trading itself.