Binary Options Strategy: Selling a Strangle

BinaryOptionsNow | Published on April 13, 2011 at 5:59 pm

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The sections below cover the sold strangle binary option trading strategy that can be used by retail traders who have access to a binary options broker that permits the naked selling of binary options.

Sold Binary Strangle Option Trading Strategy

The sold or short strangle binary option trading strategy involves selling 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 sold strangle strategy tends to be initially neutral on the direction of the underlying market.

In return for receiving an up front premium to sell the strangle, one or the other of its component binary options will require the trader pay out a fixed amount if the underlying market is better than their respective out of the money strike prices at expiration. Nevertheless, the sold binary put and binary call options that comprise each leg of the short 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 short strangle option trading strategy if they thought that the underlying market would not move substantially by the binary options strategy’s expiration time, and they thought volatility might decline.

Another possible reason for selling 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 choosing a direction in a ranging market.

This might occur when the trader expects calm or bounded trading conditions in the underlying market, such as during holidays, and when the market has not yet developed a clear trend.

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

In essence, holding a short binary strangle option trading strategy can give traders a limited risk way of profiting from ranging markets, as well as the opportunity to potentially profit from a decline in volatility or legging out of the strategy if the component positions are closed out before expiration.

Sold Binary Options Strangle Example

Consider the case of a forex binary options trader who thinks the underlying market in EURUSD will decline in volatility and that the market would not move substantially either way over the coming week. For this trader, selling a binary strangle could be a suitable option trading strategy.

If the present spot forex rate for EURUSD is 1.4000, this trader could sell a one week 1.3800-1.4200 binary option strangle. This strategy consists of simultaneously establishing a short EUR put/USD call binary option struck at 1.3800 and a short 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 receives for the sold binary options strangle on EURUSD is generally lower than that on a straddle, but usually roughly twice that received for either the 1.3800 EUR put or the 1.4200 EUR call alone.

That premium received is determined in advance and so represents the maximum trading profit to be made from that binary options strategy. Similarly, the payouts on each leg of the strangle are known in advance and the higher of these represents the maximum trading loss on the short strangle strategy.

Basically, if the underlying market eventually moves above 1.4200 or below 1.3800 by the binary put option’s expiration, then the sold binary strangle option trading strategy will result in the trader having to make a fixed payout to the holder 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 short 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 buy back the 1.3800 EUR put/USD call side of the strangle. Then, if the market subsequently moves down to 1.3800, the binary options trader can buy back the 1.4200 EUR call/USD put binary option. The result may be a higher net profit than if they had simply held both short binary options until expiration and only received the initial premium.

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