Binary Options Strategy: Buying a Straddle

BinaryOptionsNow | Published on April 11, 2011 at 10:28 pm

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The following sections cover the purchased straddle strategy that is one of the more common binary option trading strategy types used by traders who have access to a reputable binary options broker.

Purchased Binary Straddle Option Trading Strategy

The purchased straddle binary option trading strategy involves buying both a binary call option and a binary put option, each with exactly the same strike price.

Usually the strike price of the straddle is set close to the present level of the underlying or “At the Money”. As a result, the straddle strategy tends to be initially neutral on the underlying market.

In return for paying an up front premium to purchase the straddle, each of its component binary options will pay out a fixed amount if the underlying market is better than their identical strike price at expiration. Nevertheless, the binary put and the binary call options that comprise the straddle will not both pay out at the same time.

Why Traders Might Buy a Binary Options Straddle

Traders might use this initially neutral long straddle option trading strategy that involves buying both a binary put option and a binary call option if they thought that the underlying market could move substantially by the binary options strategy’s expiration time, but they were not sure in what direction the market might end up trading.

Another justification for a purchased binary straddle option trading strategy would be if the trader wanted to be in the market, but preferred not to take the extra risk of placing stop loss orders in the market that could be adversely impacted by slippage.

This could be the case when they might be expecting particularly volatile trading conditions in the underlying market, such as around key economic data announcements, without a clear sense of direction.

Binary options traders might also consider buying a binary straddle if they think that implied volatility will rise and price swings in the underlying market will increase.

Basically, holding a binary straddle option trading strategy can give traders a limited risk way of participating in such fast markets, as well as the opportunity to profit from both up moves on the call side of the straddle, as well as from down moves on the put side.

Purchased Binary Option Straddle Example

Consider, for example, the case of a forex binary options trader who is of the opinion that the underlying market in EURUSD will increase in volatility and that the market may move substantially in either or both directions during the coming week.

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

The premium that the trader pays for the purchased binary option straddle on EURUSD would be paid in advance and would usually be roughly twice what they would expect to pay for either a EUR put or a EUR call by itself.

Furthermore, since that cost is determined in advance, it then represents the maximum amount of trading risk that the trader will be taking on that binary options strategy.

The advantage of purchasing the binary straddle is that its up front cost may well be less than any stop loss order slippage experienced if the trader’s market view is proven incorrect by a fast market that suddenly moves against them to trigger their stop order.

Nevertheless, if the underlying market eventually deviates significantly from 1.4000 as anticipated by the binary put option’s expiration, then the purchased binary straddle option trading strategy will provide the trader with its fixed payout. The payout will come from the call side if the market is above 1.4000, but from the put side if the market is below 1.4000.

Another trading strategy that can yield even more potential profit for the trader from the purchased straddle binary options strategy involves legging out of the transaction before its expiration date as the underlying market swings around the straddle’s strike price.

For example, if the underlying market moves up significantly from the straddle’s strike price, the trader can sell out the EUR call/USD put side of the straddle. Then, if the market subsequently moves down below the straddle’s strike price, the binary options trader can sell out the EUR put/USD call binary option for a higher net profit than if they had simply held both binary options until expiration.

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