Hedging | Binary Options

LEVEL: ELEMENTARY

 

Hedging binary options strategy means opening two compensating opposite options at the same time so that the options are protected. For instance, a “high” option is offset by a “low” option, and the other way round. This strategy has been successfully used in the Forex market, but it’s forbidden by some brokers. Opening two opposite, equally priced positions in the Forex market (a longer and a shorter one) causes them to counteract and, theoretically, they become neither losses or gains. Such a situation can be used when we’re not sure of the outcome of the opening position. Then, using tools such as take profit, profit target, stop loss and limit, we can minimize the risk of closing the position with a loss by opening a counteracting position.

But how can we use hedging in binary options? As we know, winning means making a profit of 70-85%, so opening two counteracting options means at least one of them is a complete, 100% loss. Globally we’ll lose either way. Even if we take into account that some brokers refund up to 15% of a failed option, then – in the best-case scenario where the potential gain from both options is 85% and the refund is 15% – we’ll break even. What kind of security is this then?

Hedging strategy and binary options

Let’s say that we open a “high”-type option at $20. According to our analysis, it’s the more probable direction than a “low”-type option. Still, we want to make sure. Therefore, without changing the asset, we open a “low” option, but at $10.

What happens when we’re right about our “high” predictions?

Let’s look at these three possibilities:

  1. the option makes 70% profit;
  2. the option makes 80% profit;
  3. the option makes 85% profit.

 

The first scenario, when our “high” option brings $14 profit ($20×70%) and our “low” option brings $10 loss, the net profit with the Hedging strategy is $4, so 20%. Adding to that the maximum possible refund that’s available with some brokers (15%), we’ve made $5.5 (14-10+1.5), so 27.5%.

The second scenario, when our “high” option brings $16 ($20×80%) and our “low” option costs us $10, the net profit with the Hedging strategy is $6, so 30%. Adding to that the maximum possible refund that’s available with some brokers (15%), we’ve made $7.5 (16-10+1.5), so 37.5%.

The third scenario, when our “high” option brings $17 ($20×85%) and our “low” option costs us $10, the net profit with the Hedging strategy is $7, so 35%. Adding to that the maximum possible refund that’s available with some brokers (15%), we’ve made $8.5 (17-10+1.5), so 42.5%.

What happens when we’re wrong about our “high” predictions and “low” is the winner?

Let’s take a look at these three possibilities again:

The first scenario, when our “low” option brings $7 profit ($10×70%) and our “high” option costs us $20, the net profit with the Hedging strategy is $13, so 65%. Adding to that the maximum possible refund that’s available with some brokers (15%), we’ve lost $10 (20-7-3), so 50%.

The second scenario, when our “low” option brings $8 profit ($10×80%) and our “high” option costs us $20, the net profit with the Hedging strategy is $12, so 60%. Adding to that the maximum possible refund that’s available with some brokers (15%), we’ve lost $9 (20-8-3), so 45%.

The third scenario, when our “low” option brings $8.5 profit ($10×85%) and our “high” option costs us $20, the net profit with the Hedging strategy is $11.5, so 57.5%. Adding to that the maximum possible refund that’s available with some brokers (15%), we’ve lost $8.5 (20-8.5-3), so 42.5%.

Is it worth it?

Hedging strategy is easy to follow. As it’s been shown, it restricts both the losses and the gains. There’s no guarantee of a stable profit. The strategy is effective when choosing brokers with the highest refunds. It’s up to the trader to know what’s most important: minimizing or maximizing the risk and gains.

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