Sometimes this volatility leads to unexpected moves that can lead to margin calls, so many brokers may raise leverage minimums before big news events. Due to this, many traders, especially those with smaller portfolios, may find it difficult to trade these kinds of events. However, traders are finding a more effective way to trade these events by moving to CFTC-regulated binary options, which offer a clear risk-to-reward outcomes while limiting that risk. With binary options, stops are not a necessity, because what matters is where price is at the time of expiration.
To illustrate this, we will look at an example of one possible binary options strategy traded on the Australian dollar currency following the RBA’s announcement. Please keep in mind that this example is for illustrative purposes only and is not a trading recommendation.
When trading currency pairs, traders must choose the pair with which to match the currency. In this case, we will look to buy the AUD against a weak currency. Since the U.S. dollar particularly has shown weakness the last two sessions, we will choose the USD against the AUD; this currency pair is shown as AUD/USD. Buying this pair means buying the AUD against the USD; while selling this pair is means selling the AUD against the USD.
It is also important to know that a choice of multiple expiration time-frames is offered; but in this case, we will choose the 7:00 a.m. EST expiration for Tuesday morning (June 7), giving this pair enough time to make its move after the initial reaction to the announcement.
The trade in this example is from a more hawkish perspective, a view that the Australian dollar (AUD) will rise following the announcement. We will choose to buy a binary option with a strike of .7420, meaning that to reach maximum profit, the AUD/USD needs to be above this strike at expiration. This pair is currently trading at .7366, or about 54 pips away from the target; so this trade will offer a good reward-to-risk on a strong upside move. This option is being offered for $20.00 per contract and has a base value of $100. This means that the risk for this trade is limited to the $20.00 paid, while the reward would be the difference between that purchase price and the $100 settlement payout ($100 – $20), which would amount to a profit of $80.00 if successful, or a 4:1 return on risk.
Traders who held the opposite view and believed that the AUD would fall following the announcement could take the other side of this trade by selling the same binary option strike instead of buying it. This option could be sold at the bid of $13.50, and that selling price would be the profit per contract on the trade if the AUD is below .7420 at the 7 a.m. EST expiration. The risk would be the difference between the selling price and contract value ($100 – $13.50), a total risk of $86.50 per contract.
This example of trading forex binary options with the AUD/USD is just one example on one instrument of how a trader may implement binary trading on event-driven strategies.
Binary options may be traded on many instruments with a variety of expiration time-frames and strikes. Their popularity is increasing with traders because they never have margin calls; they offer limited risk and clear potential rewards; and they can be traded from just about any perspective.
Note: Exchange fees not included in calculations.