Binary Options Strategy: Buying a Put

BinaryOptionsNow | Published on April 11, 2011 at 10:06 pm

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A significant number of financial markets traders have started using binary options to speculate on fluctuations in foreign exchange rates, in addition to trading movements in market index levels and commodity or stock prices.

Any good option trading guide that was written for “vanilla” or regular options will offer a series of option trading strategy types that can also apply to binary option trading.

Binary options can also often be traded at shorter maturities than vanilla options, although this will depend on what maturity choices the binary option brokerage firm used for the transaction provides.

The following sections will cover the bought binary put option strategy that is among the more popular binary option trading strategy types used by retail traders who have access to a binary options broker.

Purchased Binary Put Option Trading Strategy

This bearish option trading strategy involves buying a binary put option on the underlying market of interest. This transaction will typically involve paying an up front premium to hold a binary put option on the underlying.

A binary put option will pay out a predetermined amount to its holder if the underlying market’s price is under the option’s strike price at the binary option’s expiration date and time.

Binary put options might be available to purchase on foreign exchange rates, the level of market indexes or commodity and stock prices, depending on the particular binary options broker used for the transaction.

Why Traders Might Buy Binary Put Options

Traders could employ this bearish option trading strategy of buying a binary put option if they thought that the market could drop by its expiration time.

Another justification for a purchased binary put option trading strategy would be if the trader preferred to not take the extra risk of entering a stop loss buy order in the market on a short position, especially when they might be anticipating especially volatile trading conditions in the underlying market.

In essence, the execution of such stop orders can be adversely affected by slippage. This is where the broker working the stop order does not execute it at the requested level and instead the rate given to the traders has “slipped” to a less attractive level than was initially expected.

Binary options traders might also consider buying a binary put option if they wish to avoid having a stop loss sell order on a long position in volatile markets when they may eventually be proved correct on the expected direction of the underlying market.

Purchased Binary Put Option Example

Consider, for example, the case of a forex binary options trader who is of the opinion that the underlying market in EURUSD will likely go down substantially during the coming week, and that implied volatility may also rise as a result.

For this trader, a purchased binary put option trading strategy might make good sense. If the current spot forex rate for EURUSD is at 1.4000, this trader could purchase a 1.4000 EUR put/USD call binary option that expires one week from initiation of the transaction.

The premium that the trader pays for the purchased EUR put/USD call binary option would be paid in advance. That cost, established in advance, would then consist of the maximum amount of risk the trader will then take on that binary options strategy.

This up front cost may well be less than the order slippage observed on a stop loss order if the trader’s market view turns out to be wrong and the market goes notably higher by expiration and triggers their stop.

Nevertheless, if the underlying market eventually falls below 1.4000 as anticipated by the binary put option’s expiration, then the purchased binary option trading strategy will provide the trader with its fixed payout.

This latter scenario yields the maximum potential profit for the purchased put binary options strategy since the binary option’s payout remains constant independent of how far below the EUR put/USD call binary option’s strike price the EURUSD rate eventually goes by expiration.

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