Today we will be looking at one binary option example based on natural gas futures. Every Thursday, the Energy Information Administration (EIA) releases an inventory number that includes stocks in underground storage. This number helps determine overall supply and demand and sets a price tone for natural gas. The report is scheduled to come out today at 10:30 a.m. EST.
The weekly chart shows that inventories of natural gas have a tendency of making a high during the summer months (meaning less natural gas is being used) and that inventories significantly drop during the fall and winter months, when natural gas is used for heating during the cold weather season. However, over the latter part of the summer, inventories have been dropping, and they seem to be in a downward trend already.
Today’s number is expected to see a considerable rise in inventories. We will look at an example of how binary options could benefit traders who think that the expected rise is ambitious given the seasonality, and who hold a view that the projected number could miss, and that there could be more demand for the product and a rise in natural gas prices.
Currently, the November contract is trading at 2.628. The chart shows that the high of the week is 2.667, which is the price area targeted in this example. The example is based on the current price of an actual binary option (now at $27.00) that expires at the 2:30 EST close today. The strike is 2.660, meaning that this option will be most profitable if today’s close is higher than that strike price of 2.660. Keep in mind that the premium for this option will increase or decline throughout the day as the underlying futures price fluctuates.
Let’s look at how this trade would work. This option is currently being offered at $27.00. The purchaser of this option is limiting risk to the amount paid for the option, and the maximum profit would be the difference in the $100 payout and the $27 premium paid, which would be $73. This maximum profit would be realized if the trader holds the option till expiration and the close is higher than the option strike of 2.660. The ratio of a $73 return for a $27 premium is better than 250% return-on-risk. The purchaser of this option could also decide to exit the option before expiration to take an early profit, which would be based on the price of the premium at the time of exit.
This is one scenario that demonstrates the flexibility and favorable risk-to-reward that binary options can provide traders.