Full Review of One Touch Hedging Strategy for Binary Options
One Touch options are a high yield investment vehicle created by the binary options trading community. The One Touch options deliver some of the highest returns but also come with some of the highest risk. One touch options, at least the ones offered by Anyoption, are weekly expiry options you buy over the weekend. Even though the options only require “one touch” to be profitable this really means that the options have to close at or past the strike level at least once during the week. If, during the course of the week, the option closes at or past the strike level you receive the maximum payout, if not you lose the entire investment.
One Touch from Anyoption is offered in $100 increments. Payouts range from 150% to 350% depending on the underlying asset and the strike level. What this means is that One Touch can return 2-5 times the amount of a normal binary option.
Because of the size of returns and nature of the options One Touch is only good for really big market movements. The one touch options available over the past weekend for the Dow were based on potential 800-1000 point moves in the index. Since this type of movement is not common I only recommend using one touch when the markets are trending very strongly. I also recommend using some king of hedging strategy in order to offset the loss should the trade fail.
What is hedging?
Hedging is a technique and strategy that traders use to offset potential losses. In commodity trading businesses and individuals use futures contracts to hedge against sharp increases or decreases in the prices of raw materials. In stock trading investors may hedge using options or some other derivative instrument. With One Touch options I recommend using another binary option as a hedge. By doing this you can greatly reduce the potential losses associated with the trade and enhance potential returns. The caveat is that you need to do some math to make sure the hedge will protect you from incurring maximum loss without eating up your projected gains.
How Hedging One Touch Options Works
So, over the weekend you decide the markets are going to rally hard. You are looking for a major movement over the next week and enter into a One Touch trade. With this trade you are calling for the markets to make a very significant movement. In order to profit the underlying will have to close at or past the strike level at least one day during the week. You buy one unit at $100 for an expected return of 250% on investment. The expected return if the option fails is $0 making the risk $100 and the reward $250 (total return – the original investment).
Scenario #1 – In order to hedge this investment you could buy a $100 standard binary option at opening on Monday. Since your analysis led you to trade on a big bull movement any binary call purchased Monday morning should end the week in the money. With this being said the risk for this trade is $85 and the reward is about 70% of investment or a total of $170 (the return + the original investment). What this means is that if the One Touch option expires worthless and you lose the $100 from that trade it is offset by the $70 profit on the standard binary. This makes the total loss only $30, or 30% of the original trade. I’m sure it is easy to see how this is better than losing the entire $100. You could also increase the size of the binary call to completely offset the One Touch loss provided it does not cost more than your expected returns.
Scenario #2 – In the case that other traders make the same prediction you do and prices gap up on Monday you could hedge with a binary put. Assuming the index moves down from Monday’s elevated level the One Touch call would expire worthless and the binary put would close in the money. The profit from the put would hedge the loss realized with the One Touch trade in just the same way as the binary call would in the first scenario.
Why do binary One Touch options hedges suck?
I can’t think of a single reason because the strategy works. In the first scenario I laid out the potential loss on the combination trade is very minimal. In fact it is less than the loss you would experience on either individual leg of the hedge. The potential loss on the One Touch is 100%, the potential loss on the binary is 85% and on the combination it is much much less.
However, there are some caveats to be aware of. In the first scenario it is possible for the markets to move down during the week, causing both the One Touch and the binary call to expire worthless for a total loss of $185. A more effective hedge may by to buy a call and a put at the same time, this would limit the gains but also provide some upside and downside protection for the trade. This could also be applied to the second scenario.
Why do binary One Touch option hedges not suck?
Because the strategy works. As a hedge, the trade is effective in limiting risks. The bonus is that is is possible to have both legs close in the money. In the case of scenario #1 the price of the underlying could continue upward and trigger gains in both options. In the case of scenario #2 the underlying could close at or past the strike early in the week and then move down, creating gains in both options.
The Final Conclusion
My final word…One Touch options hedging is a strategy that I will be using. I think it will be best deployed when the markets are trending strongly. When the markets are range bound or otherwise hindered there are other techniques with better risk reward profiles.
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