The 30-minute bar chart below shows April crude oil futures going back about a week to last Thursday afternoon. This future experienced some support just above the $52.50 area late last week, shown in the lower shaded area. As crude oil rebounded, it used the $53.00 area as a pivot and then broke below that price yesterday, failing to trade back above it with a high of $52.91 overnight.
Today we will look at an interesting way to trade this market using binary options. In traditional futures markets, traders typically have to choose to be long, short or flat. However, binary options present several additional ways to position yourself for any kind of market view.
We will look at an example of daily crude oil options expiring at the 2:30 pm EST close; however, options are available with several different expiration time-frames including an hourly basis and weekly basis, as well as options on a variety of other markets. These CFTC-regulated binaries have a base settlement value of $100. The trade risk is limited, and the risk and potential reward are always predefined before a trade is entered.
Please keep in mind that the purpose of this article is educational; the intent is to illustrate some of the advantages of binary options and examples are not intended to be a recommendation of any market view or specific trade.
Each binary option can either be bought or sold. The buyer of a binary option wants price to settle above the strike price at expiration, and the risk is limited to the purchase price while the reward would be the difference between that price and the $100 value. If your view is bearish, the process would be the opposite – in that case, you would want to sell a binary option, with your potential reward being the sale price while the risk would be the difference between the sale price and the $100 settlement value.
Using the chart with crude oil as an example, traders who looked at this chart today and thought that the $52.50 support will hold but that $53.00 resistance would keep a ceiling on the market could combine both of these strikes. The table below shows currently available daily crude oil binaries.
In order to trade each of these price targets, the $52.50 binary option strike can be bought for $61.25, risking that to make $38.75 on a settlement above $52.50; and the $53.00 strike can be sold for $24.25, earning that on a settle below $53.00 while risking $75.75.
When these options are combined, this strategy gives a better risk to reward ratio because one of these positions will be guaranteed to work; then, for maximum profit, you just need the other leg of the strategy to work as well. The reward would be the total winnings of both strikes, or $63.00, if price closed at 2:30 pm ET between these two price levels. The risk taken is only from one side which amounts to $37.00, the difference between the combined potential profit and the $100 value.
Traders with a differing view of this floor and ceiling could make simple adjustments based on their market view. If you are bearish, you could sell either one of these strikes; if you are bullish, you could buy either one of these strikes. If you think that price would close outside the $52.50 – $53.00 range instead of inside of it, then you could buy the higher strike and sell the lower strike, which is known as a straddle. The choices are yours with binary options.
As in this example, if you can define a floor and a ceiling for a market, then binary trading may be great for you. Binary trading is also useful for traders who define a higher or lower target for price to reach or exceed within a certain time-frame. This flexibility and the pre-defined, limited risk are just a couple of reasons why many traders in the United States and around the world are finding binary options an ideal way to compliment their trading plans.
Note: Exchange fees not included in calculations.