Many of the futures markets have been trading slower over the last few sessions, which can make it difficult for day traders to decide on a good directional intra-day trade. Range-bound strategies, in which traders look for the market not to move very far on a given day, can be a useful tool during low volatility lulls. Today we will look at an example of how to trade binary options with a range-bound strategy, using Corn as the trading instrument.
The hourly chart below shows corn futures going back two weeks. The two horizontal lines on the charge mark the 366 level, which has been a steady floor during this time period, and 372, which has been a steady ceiling. Corn futures are currently trading at 370; and for this example, we will want to place a trade that will be profitable by targeting an end-of-day close within the 366 floor/support 372 resistance/ceiling range shown.
ZCK6 is the ticker symbol for the CBOT’s May corn futures. Binary options are offered on the underlying futures instrument. The binary options used in this example will be the daily expiration, expiring at the 2:15 EST contract close.
With this binary options strategy, in a range-bound trade, you would buy an option for the lower level strike (looking for the market to close above that price) and sell an option for the higher level strike (expecting the market to close below that price). Referring to the order tickets, for this trade on March 28th, this means you would buy the 366.0 strike at the offer of 93.00 and sell the 372.0 strike at the bid of 11.25.
Let’s look at what your risk versus reward would be for this trade, first looking at each leg individually, and then looking at the risk/reward ratio of trading them together. With these binary options, profits are calculated with using a $100 settlement payout per contract. So for the long 366.0 strike option, taken individually, your risk would be the 93.00 paid, and your potential reward would be the settlement less the premium ($100 – $93.00), or $7.00 profit if the market closes above 366.00.
The individual risk vs. reward for the short 372.0 strike option is calculated differently since you are selling it. In this case, your potential profit is the selling price ($11.25) and your risk is the settlement less that amount ($100 – $11.25), which would be a risk of $88.75 if this option were traded individually. On its own, this option would profit if the market closes below 372.0 at the close of the day’s trading.
When you combine the two options in a range-bound strategy, at least one of the two trades must succeed, reducing your risk. Your total risk when trading the legs together would be the risk of one leg minus the profit of the other ($93.00 – $11.25 = $81.75 risk per contract). (You could also take $88.75 – $7.00 = $81.75.) The maximum profit would be realized if the market closes between the strikes at 2:15 p.m. EST, and is figured by adding the profit of each leg ($11.25 + $7.00) which would be a maximum profit of $18.25 per contract.
By using using a range-bound approach, you have the opportunity to make $18.25 off of a risk of $81.75 in this trade, which is a better than 20% return in about a three-hour time-frame. Given the range shown on the chart over the past two weeks, some traders could find this an intriguing opportunity to have a chance to profit in a quiet market. In addition, the trade can be exited early if necessary if price were to move unexpectedly.
Note: Exchange fees are not included in calculations.