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Trading Forex with Binary Options
Binary options are an alternative way to play the foreign currency (forex) market for traders. Although they are a relatively expensive way to trade forex compared with the leveraged spot forex trading offered by a growing number of brokers, the fact that the maximum potential loss is capped and known in advance is a major advantage of binary options.
Defining Binary Options
Binary options have two outcomes: They settle either at a pre-determined value (generally $100) or at $0. This settlement value depends on whether the price of the asset underlying the binary option is trading above or below the strike price by expiration.
Binary options can be used to speculate on the outcomes of various situations: Will the S&P 500 rise above a certain level by tomorrow or next week? Will this week’s jobless claims be higher than the market expects? Or will the euro or yen decline against the U.S. dollar today?
For example, say gold is trading at $1,195 per troy ounce currently and you are confident that it will be trading above $1,200 later that day. Assume you can buy a binary option on gold trading at or above $1,200 by that day’s close, and this option is trading at $57 (bid)/$60 (offer). You buy the option at $60. If gold closes at or above $1,200, as you had expected, your payout will be $100, which means that your gross gain (before commissions) is $40 or 66.7%. On the other hand, if gold closes below $1,200, you would lose your $60 investment, for a 100% loss.
Binary Option Buyers and Sellers
For the buyer of a binary option, the cost is the price at which the option is trading. For the seller of a binary option, the cost is the difference between 100 and the option price and 100.
From the buyer’s perspective, the price of a binary option can be regarded as the probability that the trade will be successful. Therefore, the higher the binary option price, the greater the perceived probability of the asset price rising above the strike. From the seller’s perspective, the probability is 100 minus the option price.
All binary option contracts are fully collateralized, which means that both sides of a specific contract – the buyer and seller – have to put up capital for their side of the trade. So if a contract is trading at 35, the buyer pays $35, and the seller pays $65 ($100 – $35). This is the maximum risk of the buyer and seller and equals $100 in all cases.
Thus the risk-reward profile for the buyer and seller in this instance can be stated as follows:
- Maximum risk = $35
- Maximum reward = $65 ($100 – $35)
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- Maximum risk = $65
- Maximum reward = $35 ($100 – $65)
Binary options in forex are available from exchanges such as Nadex, which offers them on the most popular pairs such as USD-CAD, EUR-USD, and USD-JPY, as well as on a number of other widely-traded currency pairs. These options are offered with expirations ranging from intraday to daily and weekly. The tick size on spot forex binaries from Nadex is 1, and the tick value is $1.
The intraday forex binary options offered by Nadex expire hourly, while the daily ones expire at certain set times throughout the day. The weekly binary options expire at 3 P.M. on Friday.
For forex contracts, Nadex calculates the expiration value by taking the midpoint prices of the last 25 trades in the forex market, eliminates the highest five and lowest five prices, and then takes the arithmetic average of the remaining 15 prices.
Examples of Binary Options in Forex
Let’s use the EUR-USD currency pair to demonstrate how binary options can be used to trade forex. We use a weekly option that will expire at 3 P.M. on Friday, or four days from now (or Monday). Assume the current exchange rate is EUR 1 = USD 1.2440.
Consider the following scenarios:
1. You believe the euro is unlikely to weaken by Friday and should stay above 1.2425. The binary option EUR/USD>1.2425 is quoted at 49.00/55.00. You buy 10 contracts for a total of $550 (excluding commissions). At 3 P.M. on Friday, the euro is trading at USD 1.2450. Your binary option settles at 100, giving you a payout of $1,000. Your gross gain (before taking commissions into account) is $450, or approximately 82%. However, if the euro had closed below 1.2425, you would lose your entire $550 investment, for a 100% loss.
2. You are bearish on the euro and believe it could decline by Friday, say to USD 1.2375. The binary option EUR/USD>1.2375 is quoted at 60.00/66.00. Since you are bearish on the euro, you would sell this option. Your initial cost to sell each binary option contract is, therefore, $40 ($100 – $60). Assume you sell 10 contracts, and receive a total of $400. At 3 P.M. on Friday, let’s say the euro is trading at 1.2400.
Since the euro closed above the strike price of $1.2375 by expiration, you would lose the full $400 or 100% of your investment. What if the euro had closed below 1.2375, as you had expected? In that case, the contract would settle at $100, and you would receive a total of $1,000 for your 10 contracts, for a gain of $600 or 150%.
Additional Basic Strategies
You do not have to wait until contract expiration to realize a gain on your binary option contract. For instance, let’s say by Thursday the euro is trading in the spot market at 1.2455, but you are concerned about the possibility of a decline in the currency if U.S. economic data to be released on Friday are very positive. In this case, your binary option contract (EUR/USD>1.2425), which was quoted at 49.00/55.00 at the time of your purchase, is now at 75/80. Therefore, you could sell the 10 option contracts you had purchased at $55 each, for $75, and book a total profit of $200 (or 36%).
You can also put on a combination trade for lower risk/lower reward. Let’s consider the USD/JPY binary option to illustrate. Assume your view is that volatility in the yen – trading at 118.50 to the dollar – could increase significantly, and it could trade above 119.75 or decline below 117.25 by Friday. You, therefore, buy 10 binary option contracts (USD/JPY>119.75, trading at 29.50/35.50) and also sell 10 binary option contracts (USD/JPY>117.25, trading at 66.50/72.00). Therefore, you pay $35.50 to buy the USD/JPY>119.75 contracts, and $33.50 (i.e., $100 – $66.50) to sell the USD/JPY>117.25 contracts. Your total cost would be $690 ($355 + $335).
Three possible scenarios arise by option expiration at 3 P.M. on Friday:
- The yen is trading above 119.75. In this case, the USD/JPY>119.75 contract has a payout of $100, while the USD/JPY>117.25 contract expires worthless. Your total payout is $1,000, for a gain of $310 (or about 45%).
- The yen is trading below 117.25.In this case, the USD/JPY>117.25 contract has a payout of $100, while the USD/JPY>119.75 contract expires worthless. Your total payout is $1,000, for a gain of $310 (or about 45%).
- The yen is trading between 117.25 and 119.75: In this case, both contracts expire worthlessly and you lose the full $690 investment.
The Bottom Line
Binary options are a useful tool as part of a comprehensive forex trading strategy but have a couple of drawbacks in that the upside is limited even if the asset price spikes up, and a binary option is a derivative product with a finite lifespan (time to expiration).
However, binary options have a number of advantages that make them especially useful in the volatile world of forex. For starters, the risk is limited (even if the asset prices spikes up), the collateral required is quite low, and they can be used even in flat markets that are not volatile. These advantages make forex binary options worthy of consideration for the experienced currency trader.
HLOC Indicator – more 90% ITM on binary options
HLOC Indicator does not include any known indicators such as MA, RSI, MACD, etc. This indicator is completely based on mathematical calculations. It is unique in its kind! As it does not make assumptions, but completely comes to the situation on the market by mathematical calculations. It can work in any market with the appropriate settings. The indicator has a built-in tester , which is very helpful to quickly analyze the performance of the indicator for a particular currency pair with different trading methods (with a different number of martingale steps).
Characteristics of the HLOC Indicator
- Platform: Metatrader4
- Asset: Major currency pair
- Trading Time: Around the clock
- Timeframe: M5 or H1
- Expiry: 3 candles (15 min for M5 and etc.)
- Recommended broker: Binomo, Binary, IQOption
Rules of trade by HLOC Indicator
HLOC Indicator signals are simple and intuitive: up arrow – Call, down arrow – Put. Open the position ONLY on the next candle if the arrow has not disappeared:
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An arrow appears during signal generation. Naturally, while the candle is not closed, the arrow may disappear and appear, as with any normal indicator. The arrow appears-disappears because of the condition close to entering the position, but not sufficient.
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If after closing the candle the arrow has not disappeared, then we enter the deal. If the arrow has disappeared, then do not enter, then the condition has not come as it should.
There are not very many signals, so for those who like more rhythmic trading, I recommend installing the template on several currency pairs at once:
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The HLOC Indicator settings have two sections:
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- Indicator settings
- Tester settings
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Bar – period of analysis of a candles. According to the value of this parameter, the indicator analyzes the specified number of candles. The optimal period is from 10 to 50. The smaller the value, the more signals. For aggressive trading 10, for the conservative (best) 20-25.
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Trend_Bar – trend analysis. This parameter is determining the direction of movement of the currency. The optimal values are from 3 to 7.
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Optimal settings with the best results:
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- Bar – 10, Trend_Bar – 3
- Bar – 15, Trend_Bar – 4
- Bar – 21, Trend_Bar – 5
In addition, you can choose individual settings for each currency pair, this can be done in the tester settings. This is a unique tester that can show the results of your settings on the history both in a year (depending on the maximum quotes history in your terminal) and in 1 hour.
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Tester – enable tester.
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Start_Date – test start date.
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End_Date – test end date (the default is 2020, that is, testing will be performed to date).
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Expiration – this parameter allows you to calculate the situation with any expiration time. That is, if you conduct a test on the M1 timeframe and want to make bets with the expiration of 3 candles (3 minutes), then set the number “3”, and the tester will calculate the result by 3 candles after the signal.
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Martingale – this parameter allows calculations to be made using the Martin Gale method. For a more accurate calculation you can use Binary Options Martingale Calculator.
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0 – not used martingale. 1 deal.
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1 – 1 deal + 1 martingale step, total result with 2 deals.
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2 – 1 deal + 2 martingale step, total result with 3 deals, etc.
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Time_Start – test start hour.
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Time_End – test end hour.
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Step_arrow – indentation of arrows from candles.
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Alert_MT4 – notification in MT4.
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Alert_Email – notification to the Email.
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Alert_Mobile – notification on your phone.
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- Do not use the martingale method with step of more than 1.
- Do not trade for half an hour before and after the release of important economic news.
- Skip the following signal after a loss:
- Trade only during the flat. At the moment, the indicator shows the best results in the low-volatile market.
- Be sure to practice on a demo account before starting a real trade.
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