Binary Options Strategy: Buying a Call Spread

BinaryOptionsNow | Published on April 11, 2011 at 9:28 pm

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Binary options have grown in popularity recently as a trading vehicle suitable for those speculating on foreign exchange rates, as well as commodity, stock and market index prices.

As with regular options, binary options can be combined into option trading strategy types similar to those described in just about any option trading guide. The main difference with binary options is that they provide a fixed payout at expiration, rather than a return that depends on the time to expiration and price like regular vanilla options.

The following sections describe the purchased call spread binary option trading strategy employed by some retail traders with access to a binary options broker that will permit traders to run both long and short binary options positions that do not net out.

Purchased Binary Call Spread Option Trading Strategy

This option trading strategy involves buying a binary call option and selling a further out of the money binary call option for a reduced up front premium. The risk of this strategy is limited to the premium paid that is lower than that of a purchased binary call option.

Furthermore, this strategy will pay out a predetermined amount if the underlying market’s price is above the first binary option’s strike price at its expiration time.

Nevertheless, that payout amount will be reduced by the payout amount on the sold call option with the higher strike price should the market end up above its strike price at expiration.

Why Traders Might Buy Binary Option Call Spreads

Traders could employ this bullish option trading strategy if they anticipated that the market could rise somewhat by its expiration time, without much of an accompanying rise in implied volatility.

The purchased binary option call spread strategy could also be advantageous if a trader wanted to reduce their premium payment, while still limiting their risk to the premium paid initially.

Furthermore, buying a binary options call spread could also help the trader avoid the added risk of stop loss sell order slippage or being triggered on a stop loss sell order before ultimately being proved correct on the market’s anticipated upward direction.

An additional advantage of purchasing binary call option spreads occurs in especially volatile markets where an outright option purchase would tend to be prohibitively expensive.

Purchased Binary Option Call Spread Example

Consider the example of a forex binary options trader who thinks that the market in EURUSD will rise somewhat over the coming week, without much of an accompanying rise in volatility.

A purchased binary option call spread strategy might make sense in this instance. Accordingly, if the current spot rate for EURUSD is 1.4000, this trader might purchase a 1.4000 binary call option and simultaneously sell a 1.4200 binary call option.

The premiums for the two options partially net out so that the binary options strategy costs less than a purchased binary call option in case the trader’s view is incorrect and the market goes lower by expiration.

Nevertheless, if the market rises above 1.4000, but stays below 1.4200 by expiration, then the first binary option will pay out, but the second will not. This results in the maximum profit for the call spread binary options strategy.

Furthermore, if the market rises above 1.4200 by expiration, then both options will pay out, with the resulting profit to the trader being reduced by the payout on the sold 1.4200 EUR call/USD put option.

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