Three Things To Consider When Trading A Binary Strangle

Three Things To Consider When Trading A Binary Strangle
Three Things To Consider When Trading A Binary Strangle
Three Things To Consider When Trading A Binary Strangle Getty Images

When the crude oil report is released every Wednesday morning at 10:30 a.m., ET, it will more than likely cause the oil market to move. There are three things to consider before you start trading this news event:

  1. Timing: When do you think the market will move? It usually moves about the time the report is released.
  2. Distance: How far do you expect the market will move? Plotting Deviation levels can help you know expected movement.
  3. Risk and Reward: Your target goal needs to be 1:1 risk/reward ratio or better.

A strangle trading strategy is used when you know there will be movement, but you don’t know the direction of the move.

Deviation levels change daily as they are based on settlement value. Using deviation levels available recently on CL (Crude Oil), settlement was at 38.10 with full +/- 1.0 deviation levels at 39.28 and 36.92 respectively. Each of these moves represents a move of $1.18 from settlement. Around seventy percent of the time, the market will move up or down one deviation level, but not beyond. There are also deviation levels at +/-0.5 and +/-0.7, which can offer support or resistance. Knowing the potential distance the market may move can help you when planning your trades.

Setting Up The Strangle Trade

            Step 1:  BUY a binary above the market, within the expected move taking into consideration how much time must be allowed for the market to move the expected distance.

Step 2:  At the same time, SELL a binary with a strike below the market, with a time and distance that will give you a risk/reward ratio of 1:1 or better.

If the market is currently at 37.87 and knowing a full deviation is 1.18, round slightly if necessary and look to buy a strike around 38.85 or 39.00. Look for a sell strike around 36.85 or even 37.00. It is best when you can find strikes that have an equal distance from the current market and strangle the trade. Both contracts should have the same expiration time.

 Figure Risk/Reward

You want to have an equal amount of risk on each side of your trade. When buying, your risk is the price you paid for the binary. If you bought at $10, your risk is $10. When selling, your risk is $100 less the sold price. If you sold a binary at $90, your risk would be $100 – $90 for a risk of $10 on this side of the strangle.

Remember, you want a risk/reward of 1:1 or better. Combine the risk of both binaries together, so the example above has a total $20 risk. Therefore, you should have an expectation that oil will move far enough to recover your original $20 risk on one of the sides of the strangle and make a profit of $20 for a risk/reward of 1:1. You are risking a total of $20 and expecting one side to profit, while the other side will most likely lose. In this example, the losing side would lose $10, so the profitable side needs to make $30: $10 to cover the losing side and $20 to make the risk/reward 1:1. Your total net profit goal of the profitable side needs to equal $30.

This is a low risk trade as the worst that can happen would be having the market remain flat and you would lose the $20 originally invested. Remember, you can always exit the trade at any time to lower the loss on the trade.

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