One very useful way to use binary options is for hedging purposes. That is why this article was designed to show you some clear and basic steps you can you binary options for that matter. To begin with the theory, hedging is a well-known strategy that can help traders to reduce or neutralize risk.
How can you use binary options as a hedging tool?
Let’s say you are trading the forex market, stocks or indices. When it comes to trading, there are always risks involved, so the market can go against your position. In order to minimize that risk, you can do the following thing.
Let’s use a clear example, in order to explain a little bit better. Suppose you are trading long 1 lot on the GBPUSD, or cable, one of the best known currency pairs.
Your stop loss is placed 40 pips below your entry and your take profit is 80 pips above the entry. With that being said, you risk to lose 400 US dollars, if the stop loss is hit and you could earn 800 US dollars in case the take profit is hit.
That 400 US dollars risk might sound too much, so you want to take precautions in case the market will go against you and hit your stop loss.
In this situation you can place a put option on the GBPUSD, of let’s say 300 US dollars. If the market will truly hit your stop loss, your long position will close with a 400 US dollars loss. But by adding to that, 85% of the 300 US dollars you’ve put on the put option, you have managed to reduce your loss by more than 50%.
In case the long position will hit the take profit, you’ll make 800 US dollars in profit and lose 300 US dollars, resulting a 500 US dollars profit.
The profit had been reduced, but you have also reduced the risk associated with the position. That is exactly what hedging was designed to do and professional traders know how to take advantages of this kind of tools. Hope you found this article useful!
Risk Warning and Disclaimer
Trading binary options carries a high level of risk, and may not be suitable for all investors. Before deciding to invest in binary options you should carefully consider your investment objectives, level of experience, and risk appetite. No information or opinion contained on this site should be taken as a solicitation or offer to buy or sell any currency, equity or other financial instruments or services. Past performance is no indication or guarantee of future performance.