Volatility of Crude Combined with Limited Risk

Volatility of Crude Combined with Limited Risk

Over the past few weeks, crude oil futures have been selling off; and yesterday, it had a huge break to the downside which has continued into today’s session.

Volatility of Crude Combined with Limited Risk
Volatility of Crude Combined with Limited Risk Getty Images

It can be difficult to enter a market this volatile while at the same time managing risk.  The chart below shows how, after making the $43.76 low, crude saw a rally up to $45.90, just barely missing the 50% retracement from yesterday’s high reflected by the green price line on the chart.

Some traders will use a 50% retracement as resistance during a trend or for a directional bias. With this viewpoint, as long as crude holds below the $46.00 level, there would reason to believe that this market will retest the lows.

Also, since failing at this 50% retracement level, crude is shown resuming its trend to the downside according to the Heikin-Ashi bars.

Volatility of Crude Combined with Limited Risk

Today we will look trading at this overall trend in crude oil using binary options, which are a helpful tool for managing risk in a volatile market. The example used is for illustrative purposes and is not intended to be a recommendation of any market view.

With binary options, the risk is limited to a predefined amount when the trade is entered.  There are never any margin calls, and in addition, trades can be entered for a lower dollar amount than traditional futures, allowing traders to further limit risk.

Let’s look at an example of how this would work.  Using the idea that crude has resumed its downtrend, you would first decide on a price target.  When you believe that a market will settle below a strike, you would sell that option, and that sale price would be the potential profit, while the risk would be the difference between the sale price and the $100 expiration value of the option.  

In our example, since the underlying is at $45.37, the $45.00 2:30 p.m. EST daily expiring strike is just .37 out-of-the-money and could be a good choice for a trade.  Volatility of Crude Combined with Limited RiskThis strike could be sold for $65.50, meaning that if the settlement is below the $45.00 strike price at expiration, the profit on this option would be the sale amount of $65.50.  The risk for this trade would be $34.50, the difference between the sale price and the $100 value, which means that the payout would return nearly 200% on risk.

With binary options, you have the choice to hold the trade until expiration, or to exit the trade early if desired, either to take an early profit or limit your losses.

You also have the choice to purchase binaries instead of selling them if you are bullish on a market.  When buying an option, the buyer needs price to settle above the strike while risking the purchase amount to earn the difference between that price and the contract $100 value.  This $45.00 strike could be bought for $73.50, risking that amount to potentially earn $26.50.  Several other strikes are also available if you had a different price target.  

Either way, with crude oil so volatile right now, binary options offer a great way to trade this market since all binary options and strategies involve limited and defined risk.

 

Note: Exchange fees not included in calculations.

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