In the United States financial markets, this week could be the most highly anticipated week of the year, and perhaps even the most watched period in over a year, as the Federal Open Market Committee (FOMC) begins its two-day meeting today with an afternoon press conference tomorrow. The anticipation is centered on the Fed considering the idea of the first rise in interest rates since 2006; and at this point, to most analysts and commentators as well as traders of the Fed Funds Rate futures, the conclusion is a given that rates will be raised.
The equity market reaction is difficult to predict since the current situation is unprecedented; but if the Fed announces a rate increase, and possibly even if it does not, the markets could experience quite an increase in volatility. That’s where binary options come in. Binary options are a very overlooked market, but they can be used to limit risk and provide creative ways to profit from market fluctuations, as long as the trader looks for an exchange that will provide flexible binary options on multiple markets.
Let’s look at one example of profiting on a market reaction, whether higher or lower, using binary options. Currently the CME® E-mini S&P 500 Index® Futures are trading at 2023.00.
In this example, if a trader could purchase the weekly expiration 2058.50 option for a price of $30.25 and sell short the daily expiration 1998.50 option for $62.50. This position includes both options and amounts to a “strangle,” allowing the trade to reach maximum profit if the index closes higher than 2058.50 or lower that 1998.50 on today’s 4:15 EST close. This allows for a 25-35 point move on what could be a very volatile week.
The amount of risk for this trade is determined by adding the amount paid on the 2058.50 option ($30.25) and the difference between the credit on the 1998.50 option, $62.50, and the $100 payout ($37.50), which results in a risk of $67.75.
The amount of potential profit in this trade would be the payout for the winning strike minus the loss from the unprofitable strike. For example, if the index closed above 2058.50, the profit would be the difference in the $30.25 paid and the $100 payout ($69.75) minus the loss of the 1998.50 option ($37.50) which leaves the trader with $32.25.
On the other hand, if the index were to close below 1998.50, the profit would be the difference between credit received on that option ($62.50) and the loss from the premium on the 1999 ($30.25) which, in this case, also results in a profit of $32.25.
This example equates to a $32.25 profit on $67.75 of risk (nearly a 50% risk-to-reward) on a trade that allows profitability whether the markets close higher or lower.
Now if you thought the Fed would again sit tight and do nothing on rates, the strategy could be doing the opposite. There are lots of choices and Binary options allow traders flexibility to profit in a variety of market situations with limited market risk.
Note exchange fees not included in calculations