Hedging Binary options is one of the many good strategies those are commonly used by the investors. It benefits the investors when they have two different options within the same expiry period and both the options can expire in in-the-money. In this situation hedging binary options will help you to minimize the risks and at the same time maximize the gains.
Although this strategy can implemented in any stream of binary option trading, it is generally used while trading in forex binary option. Hedging binary option is useful in forex binary trading as the price of the currencies change at a very fast pace which can go in any direction. In this situation of uncertainty, hedging can be used as a potential option to reduce the traders exposure to risk.
Let us take an example which will help us to understand the hedging strategy better. Let us consider forex binary option trading in Euro/Dollar currency pair. The price of Euro is on the rise and it is expected that it will continue to rise till it reaches a certain point. So, to gain from this assumption, you place your call at the current price of Euro. But suppose after you place the call, the value of Euro starts declining at a fast rate. Then you get into a tight situation. To avoid getting into this type of situation, you also have a put option at some other point which helps you to mitigate the potential risk. So, even if the price does fall, you dont end up losing a good amount of money.
As per the above example, you put a call of $ 500 when the price for the pair was 5.1. Then you place a put of the same denomination of $ 500 but when the price was 5.3. The below mentioned outcomes are possible from this trade:
* The first possibility is that the price of Euro expires at exact 5.1. In this situation you would get $ 850 above your investment. This means that you would receive $ 1350 from your trade. You had invested $ 1000 in this trade. So, your net profit would be $ 350.
* The value of the Euro expires at 5.2 which is in-between 5.1 and 5.3. This would be again profitable as the previous case, but this time you would earn $ 850 from both the trades. This means your net profit would be $ 700.
* The third situation is that the price of Euro ends up below 5.1, thus your option being out-of-the-money. From your first investment, you would receive $ 75 but you would receive $ 850 on your Put investment as this trade is in-the-money. This trade would end up in loss of $ 75 over an investment of $ 1000. Although this trade would end up in loss, but the loss has been minimized because of the Put option.
As we can see in the above example, Hedging of binary option helps to minimize the losses and at the same time it doesnt put more burdens on the profits.
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