What is a strangle strategy using binary options?

Strangle strategies for trading binary options are perfect for moving markets. When you employ a strangle strategy, you have the potential to profit whether the market goes up or down, making it a great choice for volatility.

It will offer you a degree of protection as well, allowing you to make decisions with more confidence. Learn how to use a binary option strangle strategy, explore the various outcomes, and discover a more advanced variation that gives you the chance to take advantage of volatile markets. 

What is a strangle? 

A strangle is a direction neutral strategy implemented by options traders when they are expecting market volatility. It involves buying out-of-the-money contracts and selling in-the-money contracts as the trader hopes to buy low and sell high or sell high and buy back low. Strangle strategies help protect traders in the event the markets don’t behave as expected, while still allowing them to potentially profit from volatility. 

How does a strangle strategy work with binary options? 

Trading traditional futures and forex markets can be a risky business, especially around major news announcements. These are some of the challenges traders can face: 

  • Picking direction: when trading the underlying market, you have to pick one direction for each trade and hope you are correct. The information in major news releases is so closely guarded traders have very little, if any, insight into what any given report may contain until the moment of the release. This information vacuum makes it exceptionally difficult to find any guidance into which way the market may move.

  • Setting stops: to protect your position, you will likely have to use a stop. Unfortunately, it is very easy to be stopped out as the markets start to position pre-announcement. Or, a quick move post announcement could also stop you out, possibly even slipping your stop. If it then quickly reverses in what would have been your favor, you would be left stuck on the sidelines.

  • Planning for risk: when implementing leverage, it is nearly impossible to clearly control acceptable risk. Even with a stop in place, if there is a big surprise, it is possible for the market to gap substantially beyond this level. This is how major losses can occur.

Using a binary option strangle strategy can help you profit if you’re on the right side of a larger market move, and protect you if you’re on the wrong side of it. These are some of the direct benefits: 

  • Direction neutral. There is the opportunity to profit regardless of market direction.

  • No stops are needed. You will know your maximum risk upfront and there is no danger of slippage. You also won’t be stopped out of a trade too early, so you can see your trade through to expiration.

  • Losses don’t spiral out of control. Your maximum loss is only ever the amount you put into the trade.

How to trade a strangle with binary options 

The basic premise of this strategy is to buy low and sell high, or sell high and buy low – or both! 

There are two trades, or legs, involved to implement the strategy: 

  1. Sell an in-the-money (ITM) binary option contract at $75 or greater.

  2. Buy an out-of-the-money (OTM) binary option contract at $25 or lower.

You may want to set a limit order on both legs, typically around 1.5 to 2 times the risk on either side of the trade. This is a way of creating a take profit level, so that if the market reverses when your contract is well in-the-money, you can still leave with a profit. 

The trade is structured so that if the market moves up, it takes the OTM binary option contract to ATM (near a price of 50) or ITM. Alternatively, if it moves down, it would take the ITM binary option contract to ATM or OTM. 

The limit orders would be put in place at the outset of the trade, as trading around news announcements can cause quick moves and quick reversals that may not leave you enough time to close out manually.

Strangle strategy examples 

Let’s take a look at an example of a trade setup using the binary option strangle strategy, along with a few potential outcomes. 

Here’s the scenario: 

It is Wednesday morning, and the US Federal Reserve will be announcing a monetary policy decision early in the afternoon. The EUR/USD is trading near 1.1070. 

You set up the following trade: 

  • Sell five ITM contracts: EUR > 1.1040, at a price of 84.75

    • Place a limit order to buy five contracts with the strike 1.1040, at 55.00

  • Buy five OTM contracts: EUR > 1.1100, at a price of 16.50

    • Place a limit order to sell five contracts with the strike 1.1100, at 45.00

To work out the maximum risk on this trade, you combine the maximum risk on both sides. The order ticket will tell you this – for the purpose of this example, the math is: 

  • Five contracts sold at 84.75 equals a risk of $76.25

  • Five contracts bought at 16.50 equals a risk of $82.50

  • Total maximum risk = $158.75

Now, let’s take a look at some potential outcomes. Please keep in mind, every trade is different – these are just examples. 

Outcome #1 – total loss

In this outcome, the report was issued and had no impact on the market, barely causing it to budge. The trader held onto all contracts until expiration and took a total loss of $158.75.* 

While this outcome shows a total loss, it would have been possible to attempt to close out the trade early if the markets weren’t behaving as expected. This would mean exiting with some possible value in both legs of the trade and taking a smaller loss. 

Outcome #2 - $66.25 profit from rallying markets

In this outcome, let’s suppose the market rallied to 1.1100 and the limit order for five contracts at 45.00 was filled.

This would mean the trader’s profit was $66.25.* Here is how the math works:

  • Five contracts bought at 16.50 and sold at 45.00 = $142.50 profit

  • Five contracts sold at 84.75 settle at 100 = $76.25 loss

  • $142.50 - $76.25 = total profit of $66.25*

Outcome #3 - $66.25 profit from a market drop

In this outcome, let’s suppose the market drops to 1.1040 and the limit order for five contracts filled at 55.00.

This would mean the trader’s profit was also $66.25.* Here is how the math works on this side: 

  • Five contracts sold at 84.75 and bought at 55.00 = $148.75 profit

  • Five contracts bought at 16.50 settle at 0 = $82.50 loss

  • $148.75 - $82.50 = total profit $66.25*

Outcome #4 – $291.25 profit from a reversing market

In this final outcome, let’s suppose the market initially rallied to 1.1100 and then reversed, dropping below 1.1040. 

In this outcome, the trader’s profit is $291.25.* Here’s how the math works: 

  • Five contracts bought at 16.50 and sold at 45.00 = $142.50 profit

  • Five contracts sold at 84.75 and bought at 55.00 = $148.75 profit

  • $142.50 + $148.75 = total profit of $291.25*

This works the opposite way around too. Let’s suppose the market initially falls to below 1.1040 then reverses, climbing above 1.1100.

The trader’s profit will also be $291.25.* Here’s why: 

  • Five contracts sold at 84.75 and bought at 55 = $148.75 profit

  • Five contracts bought at 16.50 and sold at 45.00 = $142.50 profit

  • $142.50 + $148.75 = total profit of $291.25*

*Examples not inclusive of exchange fees.

Binary option strangle strategy – variation for more advanced traders 

Once you’re comfortable with using a binary option strangle strategy, you have the option to try out this more advanced variation. It uses a very similar setup, the difference being that you set fewer limit orders which can allow you to make a higher profit – but also has a higher risk of loss. 

An example using a variation on a binary option strangle strategy 

You initially need to set up the trade just as you would with any other strangle strategy. To recap, this means: 

  1. Selling an in-the-money (ITM) binary option contract at $75 or greater.

  2. Buying an out-of-the-money (OTM) binary option contract at $25 or lower.

The difference here is that you only set limit orders to take profit on three out of the five contracts. This gives you the potential to make a greater profit by letting the other contracts run until expiry – the downside being that you could also take greater losses.

Here is the structure to set up the strategy variation: 

  • Five contracts sold ITM: EUR > 1.1040 at a price of 84.75

    • Limit order placed for three contracts: 1.1040 strike at 55.00

  • Five contracts bought OTM: EUR > 1.1100 at a price of 16.50

    • Limit order placed for three contracts: 1.1100 strike at 45.00

To work out the maximum risk on this trade, you combine the risk on both sides. The order ticket will tell you this – for the purpose of this example, the math is: 

  • Five contracts sold at 84.75 equals a risk of $76.25

  • Five contracts bought at 16.50 equals a risk of $82.50

  • Total maximum risk = $158.75

Now, let’s take a look at the possible outcomes. Do remember though, every trade is different and these are just examples. 

Outcome #1 – total loss

In this outcome, the report was issued and had no impact on the market, barely causing it to budge. The trader held onto all contracts until expiration and took a total loss of $158.75.*

It would also have been possible for the trader to attempt to close out the trade early and limit losses. 

Outcome #2 - $176.25 profit from rallying markets

In this outcome, let’s suppose the market rallied to 1.1100 and expired above the strike. The limit order for three contracts at 45.00 was filled, and the two contracts the trader bought and left to run until expiry closed at 100. 

This would mean the trader’s profit was $176.25.* Here is how the math works:

  • Three contracts bought at 16.50 and sold at 45.00 = $85.50 profit

  • Two contracts bought at 16.50 settle at 100 = $167 profit

  • Five contracts sold at 84.75 settle at 100 = $76.25 loss

  • ($85.50 + $167) – $76.25 = total profit of $176.25*

Outcome #3 - $176.25 profit from a market drop

In this outcome, let’s suppose the market dropped to below 1.1040 and expired below the strike. The limit order for three contracts at 55.00 was filled, and the two contracts the trader sold and left to run until expiry closed at 0. 

This would mean the trader’s profit was $176.25.* Here is how the math works:

  • Three contracts sold at 84.75 and bought at 55.00 = $89.25 profit

  • Two contracts sold at 84.75 settle at 0 = $169.50 profit

  • Five contracts bought at 16.50 settle at 0 = $82.50 loss 

  • ($89.25 + $169.50) - $82.50 = total profit of $176.25*

Outcome #4 – $311.25 profit from a reversing market 

In this final outcome, let’s suppose the market initially rallied to 1.1100 and then reversed, dropping below 1.1040. 

In this outcome, the trader’s profit is $311.25* because:

  • Three contracts bought at 16.50 and sold at 45.00 = $85.50 profit

  • Two contracts bought at 16.50 settle at 0 = $33.00 loss

  • Three contracts sold at 84.75 and bought at 55.00 = $89.25 profit

  • Two contracts sold at 84.75 settle at 0 = $169.50 profit

  • ($85.50 + $89.25 + $169.50) - $33.00 = total profit of $311.25*

This works the opposite way too. If the market initially fell below 1.1040 then reversed to climb above 1.1100, the trader’s profit would be the same:  

  • Three contracts sold at 84.75 and bought at 55.00 = $89.25 profit

  • Two contracts sold at 84.75 settle at 100 = $30.50 loss

  • Three contracts bought at 16.50 and sold at 45.00 = $85.50 profit

  • Two contracts bought at 16.50 settle at 100 = $167.00 profit

  • (89.25 + $85.50 + $167.00) - $30.50 = total profit of $311.25*

*Examples not inclusive of exchange fees.

Key points on binary option strangle strategies 

  • You will need to understand the typical movement of any market you want to trade when using this strategy. If you are picking strikes that are 100 points away from the market when it is only likely to move 30 points, you may have a cheap trade, but one that is not likely to profit. Additionally, if you have a market that would commonly move 100 points, but you choose strikes that are only 30 points away, you are probably not maximizing your potential return.

  • Try out this strategy with your demo account first. Practice it and study it. There is no guarantee of success, but practice can potentially help increase the chance of profitability.

  • Many traders recommend trading multiple contracts, but only using limit orders to take profit on a portion of the position in order to maximize profit potential.

Once you learn this strategy, you can try out some variations. Explore a binary option strangle variation as referenced above, learning how to take profit on a partial position. 

Conclusion

The binary option strangle strategy and variation offer two great ways to trade when you predict big market movements. They allow you to hold positions as both a buyer and a seller if you think there will be a significant shift on a particular market, but you’re unsure of the direction. 

While a binary option strangle strategy does give you a chance of profiting, no strategy will work 100% of the time. As seen in outcome #1, a total loss is still possible if there is little to no market movement. You must always consult your trading plan before employing any binary option contract trading strategy, making sure you don’t risk more capital than you can afford to lose. If properly managed, and when employed at opportune moments, binary option strangle strategies can be a highly useful part of your trading plan. 

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