Binary Options Strategy: Buying a Put Spread

BinaryOptionsNow | Published on April 11, 2011 at 9:46 pm

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Binary options have increased in popularity lately among those traders speculating on foreign exchange rates, as well as commodity, stock and market index prices.

Similar to regular options, binary options can be combined into option trading strategy types like those detailed in just about any option trading guide. The main difference observed with binary options is that they offer fixed payouts at expiration, rather than returns that depend on the time remaining to expiration and the price of the underlying, as with regular options.

The sections below describe how a purchased put spread binary option trading strategy could be used by retail traders that have access to a binary options broker which permits traders to have both bought and sold binary options positions simultaneously.

Purchased Binary Put Spread Option Trading Strategy

This option trading strategy involves buying a binary put option and selling a further out of the money binary put 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 put option.

Furthermore, this strategy will pay out a predetermined amount if the underlying market’s price is below 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 put option with the lower strike price should the market end up below its strike price at expiration.

Why Traders Might Buy Binary Option Put Spreads

Traders could employ this bearish option trading strategy if they anticipated that the market could fall somewhat by its expiration time.

The purchased binary option put spread strategy could also be advantageous if a trader wanted to reduce their premium payment, while still limiting their trading risk to the premium they pay up front.

Furthermore, buying a binary options put spread could also help the trader avoid the added risk of stop loss buy order slippage or being triggered on a stop loss buy order before the market eventually moved in the anticipated downward direction.

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

Purchased Binary Option Put Spread Example

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

Such a market view might make a purchased binary options put spread strategy seem attractive. If the current spot rate for EURUSD is 1.4000, this trader might purchase a 1.4000 binary put option and simultaneously sell a 1.3800 binary put option.

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

Nevertheless, if the market declines below 1.4000, but stays above 1.3800 by expiration, then the first binary option will pay out, but the second will not. This results in the maximum profit for the purchased EUR put spread binary options strategy.

Furthermore, if the market declines below 1.3800 by expiration, then both options will pay out, with the resulting profit to the trader being reduced by the payout on the sold 1.3800 EUR put/USD call option.

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