As a trading vehicle, binary options have become increasing popular in recent years. They are especially suitable for those interested in speculating on commodity and stock prices, forex rates and market index levels.
Although typically traded from the long side, binary options can be sold or combined into several option trading strategy types similar to those listed in any option trading guide pertaining to regular or “vanilla” option strategies.
While both binaries and vanilla options have fixed up front premiums, the main difference with binary options is that they have a fixed payout at expiration. This contrasts with the price sensitive payout seen with regular options.
Many binary option brokerage firms also offer binary options with considerably shorter maturities than the typical vanilla option, with binary options maturities listed as short as one week to less than an hour from initiation.
The sections below will cover the sold binary put option trading strategy that traders can employ if their binary options broker permits naked option selling.
The Sold Binary Put Option Trading Strategy
The sold or short binary put option trading strategy involves receiving an up front premium to sell a binary put option that will pay out a fixed amount if the underlying market is below its strike price at expiration.
If traders use this neutral to bullish option trading strategy, they will stand to make a profit that is limited by the premium received if their market view is correct.
On the other hand, if their view is incorrect and the market has fallen below the option’s strike price by expiration, then they will be required to hand over the binary put option’s payout to its holder.
Why Traders Might Sell Binary Put Options
A sold binary put option is a neutral to bullish strategy on the level of the underlying market. Accordingly, traders might use this sold binary put option trading strategy if they thought the underlying market might stagnate or rise by expiration, and market volatility might decline.
Another reason for selling a binary put option is if the trader did not wish to take the added risk of placing a stop loss buy order in the market on a long position that might be subject to order slippage.
Still other traders might combine a short term sold binary put option with a longer term short position in the underlying as a covered put writing strategy. Although equivalent to a sold binary call option, this strategy can enhance returns achieved on longer term short positions when the market is consolidating recent losses.
Sold Binary Put Option Example
For example, consider the case of a forex binary options trader who thinks that the underlying market in EURUSD will likely rise or stay pretty much the same over the upcoming week, with a possible accompanying decline in implied volatility.
A sold binary put option trading strategy might make sense in this instance. Accordingly, if the current spot rate for EURUSD is 1.4000, this trader might sell a 1.4000 EUR put/USD call binary option that expires in one week’s time.
The premium for the sold binary put option would be received up front. That known and limited profit would then be established, as would the total amount of risk that the trader will take on that particular binary options strategy, which would be its payout.
If the market then ends up above 1.4000 at expiration, the EUR put/USD call expires unexercised and the trader captures the entire premium received. On the other hand, if the market ends up below 1.4000 at expiration, the binary EUR put/USD call option is exercised by the holder, thereby requiring the seller to send its fixed payout to them.
Furthermore, for additional security against being having a short option position exercised by its holder, a trader might instead prefer to sell an out of the money binary EUR put/USD call option struck at 1.3800.
Although the premium received by the trader would be lower, this way, the market would have to fall below 1.3800 to trigger the binary put option’s payout to the benefit of its holder.