Binary Options Strategy: Buying a Strangle

BinaryOptionsNow | Published on April 13, 2011 at 5:19 pm

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The following sections cover the purchased strangle binary option trading strategy that can be used by retail traders who have access to a binary options broker.

The Purchased Binary Strangle Option Trading Strategy

The purchased strangle binary option trading strategy involves buying both a binary call option and a binary put option with different strike prices that are each usually a certain amount out of the money relative to the underlying market. As a result, the strangle strategy tends to be initially neutral on the underlying market.

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

Why Traders Might Buy a Binary Options Strangle

Traders might use this usually initially neutral long strangle option trading strategy 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 moving.

Another possible reason for purchasing a binary strangle option trading strategy would be if the trader wanted to participate in the market, but preferred not to take the extra risk of placing stop loss orders that could be adversely impacted by slippage in a fast market when they did not have a clear sense of its direction.

This might occur when the trader expects notably volatile trading conditions in the underlying market, such as around key economic data announcements, without the market having yet developed a clear trend.

Some binary options traders might also consider buying a binary strangle when they anticipate that implied volatility will increase and the risk of sharp price swings in the underlying market will rise.

In essence, holding a binary strangle option trading strategy can give traders a limited risk way of participating in such fast markets, as well as the opportunity to potentially profit from both up moves on the call side of the strangle, as well as from down moves on the put side if the component positions are exited prior to expiration.

Purchased Binary Options Strangle Example

Consider the case of a forex binary options trader who thinks the underlying market in EURUSD will increase in volatility and that the market could move substantially either way over the coming week.

For this trader, buying a binary strangle could be a suitable option trading strategy. If the present spot forex rate for EURUSD is 1.4000, this trader could buy a one week 1.3800-1.4200 binary option strangle. This strategy consists of a long EUR put/USD call binary option struck at 1.3800 and a long EUR call/USD put binary option struck at 1.4200 that will each expire one week from the transaction date.

The premium that the trader pays for the purchased binary option strangle on EURUSD is generally lower than that on a straddle, but usually roughly twice that paid for either the 1.3800 EUR put or the 1.4200 EUR call alone. That premium cost is determined in advance and so represents the maximum trading loss taken on that binary options strategy.

An advantage of purchasing the binary strangle is that its up front cost may turn out to be less than stop loss order slippage seen on a position established based on an incorrect market view in a fast market that suddenly moves against the trade to trigger its stop order.

Nevertheless, if the underlying market eventually moves above 1.4200 or below 1.3800 by the binary put option’s expiration, then the purchased binary strangle option trading strategy will provide the trader with the fixed payout resulting from the in the money leg of the strangle. The payout will come from the EUR call side if the market is above 1.4200, but from the EUR put side if the market is below 1.3800.

Another trading strategy involves legging out of the strangle binary options strategy prior to its expiration date as the underlying market attains one or both of its component binary option’s strike prices.

For example, if the underlying market moves up to 1.4200, the trader can sell out the 1.4200 EUR call/USD put side of the strangle. Then, if the market subsequently moves down to 1.3800, the binary options trader can sell out the 1.3800 EUR put/USD call binary option. The result is usually a higher net profit than if they had simply held both binary options until expiration and only received a payout on one leg of the strangle.

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