Trade currency exchange rates using forex binary options.
With the US Federal Reserve poised to raise interest rates and the European Central Bank committed to keeping its rates at or near zero for some time, the exchange rate between the euro and US dollar fell dramatically over much of 2014. It finally appeared to find a bottom early in 2015 and went into a volatile range with up weeks and down weeks.
During that time, the Greek economy went through a long debt crisis and a series of negotiations with its EU creditors. The US unemployment rate dropped to rates not seen since before the financial crisis. And China’s stock market, which had been booming, showed signs of weakness.
While the weakness in Europe’s economy drew investors to the US stock market, it also meant bargains for travelers to Europe and those buying European products. All of which is to say, there was plenty for traders to consider in their decision-making about the relative value of the two currencies.
In this in-depth example, you’ll trade a downward trend in the EUR/USD currency pair. You decide to sell a binary option with the expectation that it will expire in the money and you will collect $100 per contract (option).
What if the price goes up? You can exit at any time, but since you have the built-in protection of knowing your maximum possible loss up front, you’re going to use that to your advantage. Your plan is to sell an option for well over $50 and hold it until expiration. Your maximum loss is one you’re prepared to take and you also know that you can change your mind and get out early.
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 EUR/USD spot forex option is based on the current exchange rate of the worldwide, decentralized currency market. Unlike stock or futures, the price is not set by a single exchange. The forex market is by far the world’s largest and therefore has a constantly updated price. Nadex uses an underlying indicative market based on live data feeds from Reuters, Bloomberg, and other trusted sources.
For this example, let’s say the EUR/USD is trading around $1.10 to one euro.
1. Choose your market and expiration
You see that the EUR/USD has been in a downtrend for two 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. Given the clear trend direction, your hope is to sell for a price well above $50 and hold it until expiration, when the option price will be zero.
You see price resistance above 1.1040, with the market hovering underneath that level. While the market might go higher, you think there’s more downtrend to come. However, the market is volatile and you can’t be sure what it will do the whole day, so you choose a binary that will expire in an hour or less.
In the Finder panel on the left side, you choose Forex (Binaries) and under it, EUR/USD and Daily (11AM). The current time is just before 10AM and you start watching for a good entry point.
2. Strike price: your line in the sand
Every binary option is based on a simple question: will the market be above this line at this time? Since you are selling the binary option, now it’s time to choose that line—the line you think the market will be below at expiration. The seller of a binary option thinks the answer to the question is No. You’ll get the full payout even if it’s right at the strike price, but your goal is to be safely below it.
While some traders will choose their strike price from the contract list, many traders like to open a chart and do some technical analysis. Our binary ladder charts have buy and sell buttons have buy and sell buttons next to each strike level, so you can place your order right from the chart window.
Here’s how to see the chart for your particular contract. From the list of contracts, choose:
EUR/USD > 1.1040 (11AM)
On the right side of the binary ladder chart are Buy and Sell buttons next to each strike price. You click the Sell button next to 1.1040.
3. Place your order
This example is going to be a little more involved, with multiple contracts and some ups and downs. To see a simpler, but still realistic example click here. Before you can place your order, the market pops up two points in less than 10 minutes. When something like this happens, you may re-evaluate your trading plan.
In this case, you decide to use the opportunity to sell the same strike price for a higher amount, meaning a higher portion of the $100 value of the binary option. You still believe the market will head downwards before the expiration time. An order ticket will pop up. Here you choose your selling price and number of contracts.
The order ticket will show you the live bid and offer price. Since you used the chart, your order price will be filled out. In this case, it’s 66.00. If you had clicked on the contract name in the list, then the ticket will still be blank.
A great feature of Nadex ladder charts is that you can see the live chart along with the order ticket:
In this case, the market ticked upwards and the Bid price went higher, meaning more potential profit for a seller. Clicking on it will update the price window.
Or if you want to set a limit order for the price you want to pay, just type it in. Set the number of contracts (options) you want to trade.
You’ll see that your maximum profit and loss, if you place the order at that price, is calculated and shown at the bottom. In this example, let’s say we’re trading ten contracts. You can trade more or less depending on your account size and preference, but the risk/reward ratio remains a reasonably favorable one to two.
When we say that you know your risk/reward up front, you can see it right there, next to the Place Order button.
Run through the checklist one more time.
- Do you have the right expiration and strike price?
- Are you buying or selling? Did you place the correct order for the right number of contracts?
- Is your order at the price you want to pay, with the max profit and loss that you want?
Once you have those things the way you want them, click Place Order. Nadex will never take the other side of your trade. Your order is matched with that of another exchange member.
Your order will appear in the Working Orders window of the platform. If it is for a different price than the current bid, you may have to wait for it to get filled. Once it is filled, it moves to the Open Positions window.
At this point, things get interesting. The market heads back up and your trade starts losing money. It doesn’t lose the maximum possible, however. And even if the market went up dramatically, you still have the security of knowing that your risk is limited. Still, patiently enduring that red number in your Profit/Loss column is part of trading.
4. Manage your trade until exit or expiration
Knowing that your maximum risk is limited to an amount you decided on helps you focus on something other than that loss, which may or may not be temporary, but is definitely capped. Meantime, you start to see the market stop again at the blue resistance line on your chart and resume the downtrend.
Interestingly, the trade starts to become profitable even before the market price falls below the strike price. When the market is at 1.10438, the option is breaking even. Why? The option is independently traded and the price is determined by the buyers and sellers in the exchange.
As the market continues to drop (and you start to celebrate your analysis and/or luck), the binary option also moves toward expiration. With less time for it to move back above the strike price, demand for the option drops and the value declines toward zero.
You as the seller profit more as the option loses value. As the option expires, your profit maxes out.
For the sake of this example, we’re showing you how it looks to hold the options until expiration, but you could have exited early with most of that profit already locked in. Why would you do that? The market is just below your strike price, not a huge margin of safety.
In fact, this market did turn around just after expiration. It didn’t change the outcome of the trade, but a few minutes earlier and it might have. That’s why it’s important to manage the trade and have a strategy for whatever the market offers.
We designed the Nadex Trader platform and our other platforms to give you the flexibility to react to ever-changing markets with confidence. This particular trade took some unexpected turns, but because of the limited risk, you could spend your energy trading, not worrying.
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.