Scenario 1: Sniping a Short Term Movement on Long Term Stock Purchase
Where Binary Options Come In – Scenario 1: Hedging a New Stock Position
I tell you what, these binary options are great. If you’re buying a name brand security like Microsoft, Google, or VW (for your Euro-traders out there), having a binary account open at a commission free, spread free broker (like this one) is a God send. Have your binary option account and regular trading account open in a split window so you can see both on screen at the same time. Prepare your trade in regular brokerage account (or IRA account) for a market order trade. Likewise get your binary option trade ready to take the opposite direction position in the same security with a top of the hour execution.
Setting the Positions for Execution: The Long Underlying Shares Position
OK so you’ve got your two accounts open in separate windows on your screen. For simplicity’s sake lets presume you’re buying 100 shares of Microsoft at a market price ~$23.00/share. That is going to come to $2300 total. Each sudden drop in price of 1% (or $0.23/share) would represent $23.00 paper loss on your newly purchased shares. Now the question is “How to use binary options and exotic options to hedge against trading day losses.” A 1-2% unfavorable or favorable movement in a stock on a given day is not abnormal at all, so what would it take to insure against a drop of 2% (for example) using a binary option with 60% yield as a hedge?
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Also Don't Miss Out on the New Binary Options Trading Signals and Free Binary Options Trading CourseDetermining the Amount to Invest in the Binary Put Option Against the Long Shares Position
Once you have the particulars of the long position prepared you need to figure the binary put option position to use for your hedge against intra-day unfavorable movement in the long position, but how much of a binary Put do you need?
If you’re using fixed dollar binary option contracts then the answer becomes simple to compute. A 1% loss on your $2300 investment represents $23.00. A binary put option yielding 60% will pay $60 profit per $100 invested. A quick bit of algebra tells me that a $39.00 binary put option will pay out a little more than $23. Presuming the stock has fallen (even just 1 cent) as of the expiration of the binary option at the top of the hour or end of day (depending on which option you chose), you’ll have picked up $23 (commission and spread free trading is NICE!) to offset your loss. Each 1% of insurance you wish to buy essentially costs $39.00 but the beauty of it is that even if the stock falls just the amount of the spread between bid and ask on the underlying stock you still collect and now pocket the profits on the binary put trade and can use them to offset (heaven forbid) a stop loss on your MSFT position triggered down the road.
Make the Trades
In the end if the stock goes up then obviously it has moved in the direction you wanted and your binary options expire out of the money (sometimes you might get 15% back – or about $6 per 1% loss insured in this example). On the other hand if your luck is like mine and the stock drops (as sellers act at the bid price) then your binaries kick in and you re-coup any trade day misfortunes.
We’ll cover other scenarios in future postings but for now you should have some feel for the use of how to use binary options and exotic options to hedge against long stock position losses.
Readers might also wish to check out barrier options as well.
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