Hedging in stock trading is a process aimed at protecting the profit received or reducing the expected loss, improving the overall trading result.
Profit protection strategies are based on three features binary options:
- The profit and loss zone is determined by the type of binary option.
- The expectation of the transaction is negative or equal to zero. The maximum possible win for any broker does not exceed 100% (except for exotic), i.e. always less than the potential profit.
- The amount of profit and loss of the transaction is known in advance.
Profit hedging using American binary options
Traders use the American type of binary options to increase the percentage of profitable trades and reduce losses. Brokers allow you to:
Binary options strategies are taken from the stock market, the signal for the entry and the exit of which do not coincide with the expiration time. During the period of the binary option, a signal change may occur or the price will reach those levels at which a loss-limiting order would work in the market strategy (stop loss).
The broker often "ties" the return of part of the investment to the remainder of the time before expiration, so if the trader sees a strong change in the current price in the OTM zone, it makes sense to return most of the losses that the expiration of the contract will bring.
If the signal change took place on an option in "money" (ITM), the trader has the opportunity not only to return 100% of the investment, but also to make a profit. Its percentage is tied to the remaining time before expiration, the less it is, the higher it is.
Combining several types of options to hedge the "loss zone"
Each type of binary options has a profit and loss zone stipulated by the terms of the broker's specification. If the trader uses the contracts Above/Below (Call/Put) with premium accrual, in case of a correct forecast of 100%, the loss zone can be "blocked" by opening an option "Inside the range".
Such a combination has a number of features:
- the premium accrued on an investment in a binary option Above/Below, in case of a correct forecast, should be 100%;
- the size of the contract range within which the trader can count on profit should be as large as possible;
- the terms of the contract "Inside the range" (or " Spread") should contain compensation (return of part of the investment) in case of loss;
- the functionality of the broker's terminal should allow you to set pending option orders;
- the underlying asset should be the main currency pairs Forex.
The Forex market and the main currencies are selected because of the" stability " of the maximum ranges of intraday fluctuations. Knowing the maximum deviation will allow you to better predict the transaction so that the price does not pass above (or below) the range, being in the unprofitable zone of the first contract.
Initially, a binary option is opened Higher/Lower. The second, "range option" is placed as a pending order, at a price that is located in the" loss zone " at a distance of 50% of the range. Thus, if the currency exchange rate, being in the unprofitable zone, passes half of the range, it will be covered by the" triggered " second contract.
If the price expires in the range at the expiration of the option, the trader receives a loss of 100% from the "Above/Below" option and a profit of about 80% of the "Spread" option. When the price returns to the profit zone of the first option, a 100% premium will be accrued, while the loss of the investment of the second contract will be compensated by a" return " reaching up to 30%.