Contrasting Binary Strategies with Copper
Today, using binary options, we will look at opportunities to trade the copper futures market that are more creative than just buying or selling an instrument looking for it to simply go up or down.
By Davin Blythe
Thursday, May 4, 2017 - 00:00
Copper futures have traded in a mostly narrow range over the last two sessions, and yesterday this market created somewhat of a price floor at 2.590 and a ceiling at 2.600 that has held overnight into Friday’s session, as illustrated on the chart below.
Today, using binary options, we will look at opportunities to trade this market that are more creative than just buying or selling an instrument looking for it to simply go up or down.
Please keep in mind that the examples used are not intended to recommend a market view, but are illustrations of how traders may implement binary options trades.
Binary options can either be bought or sold, or traded in combination. When you purchase binary option, you want the market to settle above the strike price at expiration, and the risk would be the purchase price, while the reward would be the difference between the risk and the $100 contract payout value.
If you sell a binary option, you are looking for the market to settle below the strike at expiration, and the potential reward would be the option’s sale amount, while the risk would be the difference between the sale amount and the $100 value.
One combined binary options strategy is what is sometimes referred to as a straddle. A straddle can earn profit by a move in either direction; however, it is possible for both option postions to lose, therefore, the risk is greater. However, another way to combine options is to “sell the straddle,” which is the opposite of a regular straddle. If you sell the straddle, rather than trying to profit on a trade in either direction, you are trying to capture the market within a range. An advantage to this strategy is that one of the options must end in profit, resulting in a lower total risk on a trade.
As an example of selling the straddle, let’s say you believe copper will settle in between the 2.590 and 2.600 levels at today’s 1:30 p.m. EST close. In that case, you could sell the 2.600 option for $30.75, which would be the amount of your potential profit while your risk would be $69.25; and you could buy the 2.590 option for $65.25, which would be the amount of your risk while your potential profit would be $34.75. When these two options are traded together, the reward from both options is combined, which would result in a combined potential profit of $65.50, with a risk of just $34.50. This profit would be realized if price settles between the strikes.
On the other hand, if you believed this market was set to break out of the range, then you could trade a regular straddle, which is done by reversing the trades above - you could buy the 2.600 option for $44.75 (with a potential profit of $55.25) and sell the 2.590 option for $51.25 (with a risk of $48.75). In this instance, instead of profit resulting from a settlement between the strikes, the risk is in a settlement between the strikes. In this particular example, the total dollar amount of risk would be $93.50 to potentially earn $6.50 if price settles above or below the strikes.
Although the reward ratio in this particular example is low, based on this pricing, the market clearly believes the probability is for copper to break out of the range. This is why the straddle involves a higher dollar risk, lower reward trade. On the other hand, selling the straddle in the first example gives a trader a better dollar return on investment - about 175% return on risk - but on what the market considers to be a lower probability trade.
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