Binary Option trading strategy introduction part I

This Page gives an introduction of the main basic binary option trade and binary option strategies.

Before we start talking about Binary option trading strategies I would like to introduce the reader to the basic Trader jargon.

If a Trader anticipate the market to rise then he is bullish.    Bullish strategy
If a Trader anticipate the market to fall then he is bearish.    Bearish strategy

A bullish option strategy should be used to make profit in a rising market.

A bearish option strategy should be used to make profit in a falling market.

A rising market is called a bullish market.

A falling market is called a bearish market.

A Trader who has bought a call or a put option is said to be Long Call or Long Put

A Trader who has sold a call or a put option is said to be Short Call or Short Put

Now that the reader is familiar with the main jargon I am going to introduce a very useful tool that option Trader uses quite often. This tool simplify the understanding of all option strategies.

We saw that it exists Call and Put option. Buying a Call or a Put is the most basic option strategy, we will see later that all trading strategies is a combinaison of Calls and Puts. See below Legend:

Bullish strategyBullish strategyBullish strategy = Very bullish strategy

Bullish strategyBullish strategy = Bullish

Bullish strategy = Slightly bullish

Bearish strategy =Slightly bearish

Bearish strategyBearish strategy = Bearish

Bearish strategyBearish strategyBearish strategy = Very bearish strategy

Below the first two main option trading strategies:

1.Long Call (Buying a Call) Bullish strategyBullish strategyBullish strategy

When a Trader buy a Call he anticipates a sharp rise of the option underling. The below chart exhibits the payoff at expiry of a $50 strike binary call bought at $0.05.Binary Call payoff

2. Long Put (Buying a Put) Bearish strategyBearish strategyBearish strategy

When a Trader buy a Put he anticipates a sharp drop of the option underling. The below chart exhibits the payoff of the Put option at expiry.The below chart exhibits the payoff at expiry of a $50 strike binary put bought at $0.05.

Binary put payoff

3.Long Callspread (Buying a Call + selling a call of higher strike) Bullish strategyBullish strategy

When a Trader anticipates a limited rise of the option underling he can buy a Call and sell another Call with a higher strike to decrease the total price to pay. By selling another Call of higher strike the Trader takes an extra risk to lose all his gain in exchange of receiving the Call value.

The below two charts exhibit a $50 strike call bought at  $0.05 and a $54 call sold at $0.02

Binary call option Binary call option

The combination of the above $50 strike long call and a $54 strike short call gives the below payoff.

Binary callspread payoff

Eliminating the construction line we can isolate the Callspread strategy below.

Binary callspread payoff

 

As you can see the total price ($0.05-$0.02=$0.03) of the strategy is less than the $50 call alone however in exchange of receiving the $0.02 for the $54 call you give back your gain if the underlying goes above $54.

In conclusion if you are only a bit bullish then buying a Callspread is a best strategy than just buying a call as it is cheaper to buy and you still make money if the underlying goes between the two strikes.

3.Long Putspread (Buying a Put + selling a put of lower strike) Bearish strategyBearish strategy

When a Trader anticipates a limited fall of the option underling he can buy a Put and sell another Put with a lower strike to decrease the total price to pay. By selling another Put of lower strike the Trader takes an extra risk to lose all his gain in exchange of receiving the Put value.

The below two charts exhibit a $50 strike put bought at  $0.05 and a $46 call sold at $0.02

Long binary put Short binary put

The combination of the above $50 strike long put and a $46 strike short put gives the below payoff.

Binary putspread

Eliminating the construction line we can isolate the Putspread strategy below.

Binary putspread

As you can see the total price ($0.05-$0.02=$0.03) of the strategy is less than the $50 put alone however in exchange of receiving the $0.02 for the $46 put you give back your gain if the underlying goes below $54.

In conclusion if you are only a bit bearish then buying a Putspread is a best strategy than just buying a put as it is cheaper to buy and you still make money if the underlying goes between the two strikes.