In an article last week, we examined indicators that can be helpful in assisting traders to choose market direction and to implement binary options with that technique. Today, we will continue to look at the momentum indicator, which is a simple study that is based purely on price action and gives traders another set of eyes when looking at a chart.
The chart below shows the S&P 500 futures. The short term trend this week has already established itself in a downward direction. In a downtrend, the path of less resistance is typically to sell rallies, and the momentum indicator helps to identify when a market turn may be occurring.
The bottom of the chart shows the momentum indicator, which is making a series of lower highs. Just now, the momentum indicator has crossed over the zero line, suggesting that momentum is moving negatively; and since the short term trend is already lower, this can be seen as a double downward indicator that may signal a higher probability trade for trading downward.
We will take a look at a some examples how to trade binary options in either direction using this indicator, depending on a trader’s viewpoint. Remember that these examples are for educational purposes only. The binary strike used in both examples is used as an illustration of how to implement these options, not a recommendation of any market view or specific trade.
With the S&P 500 futures currently trading at 2273, the 2273 strike binary option is the at-the-money which expires at today’s 4:15 EST regular trading hours close. and has a base settlement value of $100.
This strike is currently is at a $47.50 bid. If you believe that momentum will follow through lower and the day will close below the strike, you could sell this option for the $47.50 bid price. This means that if the underlying instrument has a Nadex expiration value at or below the strike price, you would receive $100 settlement payout resulting in a $47.50 profit. If this binary strike has the expiration value above 2273.00, then the initial cost of the trade is forgone which is the difference between the sale price and the $100 value, or $52.50.
Alternatively, if your view was that this market would close above the strike price, you could buy the same strike at its current offer of $52.25. When buying the binary option, you want the underlying price to be above the strike at expiration; Here your initial risk would be the the binary trade price as a buyer, while the potential reward would be the difference between the trade price and the $100 settlement value, or $47.75 in this case.
With either strategy using an ATM binary option, the trade provides very close to a 100% return on risk from simply choosing whether this futures market will close higher or lower from its current price at the end of today. The momentum indicator can potentially help traders when choosing direction.
With all the indicators that exist, and with the many binary option expirations on several instruments, there are endless possibilities of how traders may use these instruments to fit their own market view with multiple risk/reward scenario’s.
Note: Exchange fees not included in calculations.