Strangle Strategy for Binary Options

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Strangle Strategy with Binary Options

Trading binary options can be profitable only when the trading plan incorporates well structured risk management technique. In this regard, most of the strategies used to trade vanilla options can be adapted to binary options trading. One such strategy is strangle, which can reduce the risk and provide higher returns from trades as discussed below.

Strangle setup

The ultimate goal of strangle strategy is to benefit irrespective of the price trend of a security being traded. There are two kinds of strangles namely the long strangle and short strangle.

In the case of long strangle, the process involves buying an call and put option (in the same asset) with identical expiry time. As long as the price moves sharply in either of the direction, there will be a net profit. This is because the loss is limited (when a call or put is bought) while the profit is unlimited in vanilla options trading. So, the contract which expires in the money will compensate more than the loss resulting from the contract which expires out of money. The strategy should be employed only when a trader expects a drastic change in the implied volatility of an asset.

The short strangle strategy involves selling a call and put option, which are respectively out of money. However, most of the binary options platforms do not offer such a facility. Thus, the feasibility of a short strangle strategy is not studied here.

However, as we can see below, the long strangle strategy can be applied successfully to certain category of binary options trades.

Binary Options Setup with Long Strangle Strategy

High/low trades (5min / 30min /1hr)

As mentioned earlier, a strangle strategy involves purchasing an out of money call and out of money put contracts. Fortunately, all binary options brokers allow a trader to take two dimensionally opposite positions.

To begin trading a contract, draw a channel connecting at least three support or resistance lines in charts with time frame below, equal and above the contract expiry period. For example, if the contract expires in 30 minutes then use a 15min, 30min and 1hr chart to draw a channel. By looking at the higher time frame chart the trend can be assessed. Similarly by looking at the lower time frame chart the entry price can be determined accurately. It should be remembered that a channel should be drawn by connecting at least three support or resistance price points as shown below.

  1. Begin the trade by assessing the trend in the higher time frame. If the price is forming lower highs within the channel then the trend is down and vice versa.
  2. If the price is forming lower highs then purchase a put option when the price touches the upper line of the channel. To determine the exact price use the lower time frame.
  3. Now, when the price touches the lower line of the channel buy a call option with same expiry time. The return would be little bit less because of the expiry time but may not be too low since the strike or target price is on the higher side.

The following are the expiry scenarios for such a strangle trade.

  1. Price goes up: The put option would result in loss while the call option would result in a profit. Assuming that expiry in the money will result in a reward of 75%, the net loss would be 12.5% of the total capital invested. If a trader had invested $200 put together in both the contracts, the net amount in hand at the time of expiry would be $175.
  2. Price goes down: The net loss would be 12.5% of the total capital invested, as explained above.
  3. Price stays in between: Both call and put options will result in profit. The net profit will be 75% over the total capital invested. A trader would have $350 in hand at the time of expiry if $200 had been invested in both the contracts.

The USD/JPY images below shows how to analyze and create a strangle setup.

As it can be understood, the strangle strategy is successful in binary options as long as the implied volatility does not change drastically. This is one of the main contradictions when compared to vanilla options. The reason is that reward in binary options trade is fixed irrespective of the distance traveled by the price in favor of a trader.

One Touch Options

A strangle setup can be created using a channel, as explained above, in a one touch options trade as well. The only difficulty is that price should touch or pierce the level indicated by the broker. When the asset’s price trades near the lower end of the channel, check for the one touch call option target price provided by the broker’s platform. If the target price is near the upper end of the channel then go for the trade. The same rules apply for the purchase of the out of money put option as well. A range bound market with spikes near the upper/lower channel lines is for this kind (one touch) of contracts.

The expiry scenario will be as follows:

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  1. Price touches the one touch call option target: The one touch put options contract will be worthless. The net loss would around 12.5% of the total sum invested.
  2. Price touches the one touch put option target: The end result will be the same as above.
  3. Price touches both the targets: The trader will make a profit of more than 75% on the total sum invested.
  4. Price stays within the channel: Since neither of the targets is touched, the trader will lose the entire capital invested.

Ironically, unlike a high/low trade, the implied volatility should be high with zigzag moves for this kind of setup to be successful.

A double one touch option is an investment vehicle structured similar to a strangle setup. The trader wins if either of the two (one above and one below) target prices are achieved. Likewise, a no touch and double no touch option contracts are theoretically far different for a strangle strategy to be implemented.

A long strangle is suitable only for experienced professionals who can analyze trend and momentum perfectly. A beginner should use this setup only after a lot of practice in a demo account.

Strangle Strategy for Binary Options

When you want to do vanilla options trading successfully you have to use the right strategies. One recommendable strategy that you can use is the Strangle Strategy.

WHAT IS IT AND DO YOU USE IT?

The Strangle Strategy relates to buying Calls that are higher than current prices and buying Puts that are lower than current prices. At the purchase time they are still Out-of-the-Money. Before you use this you have to be clear about it.

When you see a Put below the current price and the Call above the current price you may only need a stronger movement on either of the two directions. You should not ponder on directions because when prices go higher Call is profitable and when prices are lower then Put is in profit. Just if underlying assets continue moving in a single direction, the Strangle can be profitable once the Even point has been outdone. In shorter terms, you do not have to understand the underlying asset’s direction yet you can still earn great profits. What you need to have is a constant and strong movement in any of the two directions. However, you still have to put in mind that you are using Binary Options.

HOW DOES THIS STRATEGY WORK?

Primarily it is not actually possible to buy a Put or a call anywhere else than current prices. Thus, it is quite impossible to us the Strangle strategy for Binary Options. Can this strategy be used on for Vanilla Options? As a matter of fact, this is kind of a miracle because there is some way you can do this using this strategy. The answer is the Touch/No touch binary options. With this kind of trading you can bet that prices can reach at a specific level prior to its expiry time.

Thus, in order make Strangle work, you can choose the Touch option for a strike price or a price that is higher than the current price. You also need to choose another touch option for a lesser level than the present price. If you underlying assets begin to move stronger in either of the tow directions, one of the 2 binary trade can be quite profitable. This might actually mean that the Strangle works for Binary Option trading.

This is however, a theory that needs to be proven but in a realistic market condition, there are many factors that needs to be taken to serious consideration – How much can you get when your Touch trade is successful? Does the broker permit you to open 2 different Touch trades? If any of your options can be profitable can your profit compensate for your losing trade’s cost? These are some of the questions that you must only answer on the precise conditions presented by the broker whom you have been trading with.

WHY IS THIS STRATEGY NOT GOOD FOR BINARY OPTIONS TRADING?

To begin with, it is not actually a true Strangle when you use 2 Touch Options. However, it is a great adaptation. The bad thing about using 2 Touch Options is that typically the broker obliges you to bring them as far away as the present price. Thus, there is a huge change that none can be touched until there is time expires and you could probably lose on those two options. But it boils down on the broker that you trade with.

WHY IS THIS STRATEGY GOOD FOR BINARY OPTIONS TRADING?

When you trade with a broker who has a high pay out offer for successful Touch Options and there is a volatile market, you can surely make money by using the Strangle. The vital conditions are that you need a bigger payout that any of the Touch trades cover for both trades’ cost.

FINALE

With The Strangle for Binary Options, your trading can be quite profitable. However, there may still be many questions that you need to be answered. One question would be how far can you set the Touch Options from the current price. When the broker gives a Touch Option offer that is away from its current price, this may alleviate the probability of trades to lose. To sum it up, the Strangle’s success in the way being mentioned above is very reliant on the broker’s condition.

Using The Strangle Strategy On 20-Minute Binary Options (Part Of A Series)

The Strangle is not something you do when you need to take your frustrations out on a losing trade! A Strangle strategy is the exact opposite of the Butterfly strategy (which was discussed in another article using Nadex 20-Minute Binary Options.

To review that article, click HERE.

While a Butterfly is best in a flat, non-trending market, a Strangle is best when the market is choppy. The Strangle strategy requires two simultaneously placed trades like the butterfly, but they are both OTM (Out of The Money) contracts. You want to buy the upper contract and sell the lower contract.

For an article in this series which explains Out of the Money, In the Money and At The Money, click HERE.

A Strangle has low risk and therefore, no stop loss needed. You want a 1:1 Risk/Reward minimum. You are expecting that one side will lose but the profit on the other will cover the loss.

Strangles are great just before a big news event when you know it’s going to make the market move, but you don’t know which direction. There has to be movement or this trade will just decay in time value, but because it is low risk, your loss would be minimal.

Doing the Strangle strategy on 20-Minute Binary Options are quick trades.

They are low risk thus making it a great strategy for part-time traders.

Placing A Strangle Trade

As mentioned before, you want to do the exact opposite of a butterfly. Take a minute and wrap your head around that concept, because at first it may not make any sense. You want to buy an upper contract and sell a lower contract.

That goes completely against the “Buy Low, Sell High” philosophy that you may have heard all of your life. In this case however, it works to Buy the Upper and Sell the Lower because you don’t know which way the market is going to move. You just know that it is going to move, so you are putting your predictions in before it happens, hoping to become profitable.

If there is going to be news that may drop the market so far down, that your OTM sell strike price becomes ATM, you will be profitable. The opposite is also true. There are times when the news makes the market bounce so much that there is a retracement. When that happens, you end up profitable on both sides of your trade.

You will want to check your chart for a number of things before placing this trade. Again, make sure you are using Diagnostic Bars instead of Time-Based Bars. Check the Expected Ranges to see expiry times and choppiness.

The market should be bouncing up and down. Look at Expected Volume to see if the market is exceeding what was expected. The next image shows what you should be seeing when you want to place a Strangle trade.

To view a larger image, click HERE.

You will notice that the arrows show when the market breaks out of the expected range just beyond the red box area.

If you look at the Expected Volume below the chart, you will see that the blue columns, indication actual volume, are far exceeding the yellow line indicating the Expected Volume. It is also interesting to note the correspondence between the exceeded Range and Volume. Volume seems to go crazy as the market breaks through the expected range!

How Do You Know Which Strikes To Choose?

If you have closely checked your charts and they have met the necessary criteria for a Strangle strategy, you are ready to enter a trade, but which strikes do you choose?

You want to make as much as you can without risking more than $40 combined on both sides. Make sure that both contracts are OTM. The image below shows that the market is currently trading at 17893 making that strike price ATM. To place your Strangle trade, you could buy >17914 @ 18, risking $18, with a profit potential of $82, if held to expiration.

If you believe the market is going to move up at least 21 ticks in the next 18 minutes, then buying that strike makes for a great trade. The risk is low so no stop loss or take profit is needed. To complete your Strangle trade, you could sell >17865 @ 86, risking $14, with a profit potential of $86, if held until expiration and not including fees.

It is beneficial to exit when you reach your 1:1 risk/reward to profit on this strategy.

To view a larger image, click HERE.

The combined risk on this trade would be $32, which follows the guidelines for this trade. Remember, you expect one side to lose and even if that happens, your profit potential on the other side far outweighs the loss, so you will come out profitable.

It is important to understand how the risk/reward ratio works to cover any loss you may have. For the trade listed above, let’s assume the market surged way up and settled at 17919. The sell side lost the $14 that was risked.

To cover that loss, your buy side needs to make $14 plus the $18 risked on the buy side in order to be considered profitable in a 1:1 ratio. Let’s say you exited at $88 just before expiration for a profit of $70 on the buy side of your trade. Now you subtract your $14 loss and you are up $56 on this trade not including fees. Pretty good for paying attention to some news, indicators and your chart!

Now let’s look at a few real trades. All of these trades were performed within minutes of each other on 20-Minute Binary Options. There is one Strangle on each of the four indices.

All have low risk and all were profitable. Nadex fees on each of these trades would be $3.60 and would be subtracted from the net profit.
To view a larger image, click HERE.

US 500

For this Strangle, the >2052.95 was sold at 89.5 for a risk of $10.50. It expired worthless. The >2057.95 contract was bought at 10.5 also with a risk of $10.50. Total risk on the trade was $21.

The trade was closed out at 92.50 for a profit of $82 on the buy side. When the loss of the sell side is subtracted, there is a net profit of $71.50 before fees.

US SmallCap 2000

On this trade, the >1161.6 contract was sold at 91 which gives you a low risk of $9. Risking just $9.50 on the buy side, the >1167.6 was bought at 9.5 giving the trade a total risk of only $18.50.

The buy side was exited before expiration when the current price reached $93 leaving a nice profit of $83.50 for that side of the trade. The sell side expired worthless but since the risk was low, only $9 was lost on that side of the trade giving the trader an overall profit of $74.50.

US Tech 100

For a $12 risk, the >4258.0 contract was sold at 88 and expired worthless. The risk on the bought contract >4270.0 was just $9 and profited $84 at closing when its current price reached $93.

Subtract the $12 risk on the sold contract from the $84 profit for a total profit of $72 on a $21 total risk. That’s pretty good!

Wall Street 30

Total risk on this Strangle was a little higher than the other trades shown in this example, but still low at $26.50. The >17793 contract was sold for 91.5 and the >17820 contract was bought for 17. All $9.50 was lost on the sell side but the bought side ended up with a profit of $79 making the total profit on this trade $69.50.

Total profit on all four trades comes in at $287.50. Total fees would be $14.40 leaving a nice profit of $273.10 in less than 20 minutes! Remember this strategy is perfect for the times that the market is moving and you just don’t know which way it’s going to move.

Things To Remember When Placing A Strangle Trade

  • Market is choppy or volatile
  • Use only OTM Strikes
  • Look at the Expected Ranges, market should be exceeding them
  • Know about upcoming news that may affect your trades
  • Sell a Lower OTM Strike
  • Buy an Upper OTM Strike
  • Make sure both strikes have the same expiration times
  • Place the trades simultaneously
  • No Stop Loss required
  • Understand Risk/Reward and how it relates to being Profitable on this strategy
  • Expect to lose on one side
  • Have a reason for placing the trade

Conclusion

As with any new strategy that you learn, do not just jump in and think you can do this. Be sure that you try it out several times in demo before you try it live. Get a feel for how it works. Make sure you know what you are looking for in volume, range and news.

Having a reason for placing any trade is critical to successful trading. In the case of a flat market or a range bound market, you need to be able to choose a different strategy.

This is why it is important to know and be able to use various strategies that will get you the best results depending on the market conditions.

To learn more about other trading strategies and further your education as a trader, go to www.apexinvesting.com.

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

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