Hedging Forex Trades Using Binary Options

Hedging Forex Trades Using Binary Options

Fantasy golden clockwork with currency sign. Euro , dollar, yen, pound – gears working in global economics Hedging forex trades using binary options provides traders with the opportunity to trade with a way to minimize their losses on the forex side.

Hedging Forex Trades Using Binary Options
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Hedging Forex Trades Using Binary Options – EUR/USD Example

A trader with a bias to the upside on the EUR/USD enters a long position with 2 contracts at 1.1015.  He sets a stop at 1.1004.  This produces a total risk of $210 (excluding commissions).  To offset the potential loss he enters a short binary option at 1.1015 with five contracts.  The total risk on the binary option side is $256.25 and the profit potential is $243.75 (excluding exchange fees).  The binary option expires in one hour.

Hedging Forex Trades Using Binary Options

The goal in using the binary options is to offset any potential losses on the forex EUR/USD trade.  In other words, the trader is risking $210 on the forex trade but they are offsetting that loss by capturing the $243.75 profit on the binary option side.  Plus the binary option has a full hour till expiration giving the trade time to work in the trader’s favor.

By hedging the position, here are the potential scenarios that can play out:

  • EUR/USD forex trade moves up to test the previous high at 1.1030, making profits and the EUR/USD binary option has a full loss, $256.25 excluding exchange fees.
  • EUR/USD binary option moves down and realizes a full profit, $243.75 excluding exchange fees, but the trader is stopped out of the EUR/USD forex trade ($210.00 loss, excluding commissions).

Hedging Forex Trades Overcomes Losses

In this case, the EUR/USD forex trade is stopped out and a full loss of $210, excluding commissions is realized.  However, the EUR/USD binary option has covered the loss as it has a profit of $221.25 (excluding exchange fees).  By allowing the trade to expire, the full profit of $243.75 is realized.

Hedging Forex Trades Using Binary Options

In other words, by hedging forex traders using binary options the trader has turned a losing trade into a breakeven trade and his account has not suffered because the trade went against him.

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