Pair Binary Options Trading

So far, we have discussed some strategies that may be employed by new and experienced binary options traders alike. These strategies are used by traders constantly, and are fine-tuned to the specific trading styles of the traders. When they hone their skills by streamlining their strategies, they become more comfortable with trading and run into lesser risk and greater profit.

In this article we will discuss yet another commonly used binary options strategy used by traders. This strategy is called pair trading strategy. The pair strategy is a binary options technique used by traders to reduce the risks involved when trading. Many experienced traders seamlessly use this effective way to cut the amount of risk they encounter when entering a trade. But, many binary options traders can also attest that it is a good way to maximize profit and managing investments.

How Does Pair Trading Work

The mechanics of the strategy is where its name is derived. Binary options trades are done in pairs, where simultaneous or non-simultaneous trades of opposite directions are made. These trades can be made on the same or different assets, depending on the kind. The strategy can be compared to the straddle effect, but since pairs do not necessarily have to be of the same asset, it is an entire different strategy on its own.

There are three advantages to this strategy. We shall keep these in mind as we will be mentioning them when we cite examples of the use of this strategy. A binary options trader can use the pair strategy to:

  • protect profits
  • possibly double the income
  • minimize the levels of risk

The pair trading strategy can be used in different kinds of assets: Forex, commodities, and stocks. The trades can be made on a single asset only, but can also be used in two competing assets. Depending on what type of asset the binary options trader is trading on, there are also two approaches to pair trading: single-asset, and competitive pair trading.

Single-asset pair trading executes a call and a put action on a single asset at different times while competitive pair trading purchases a call and a put option on two competing companies. While both strategies are easy to understand, even for the beginner, the research that they entail need to be thorough, especially for the competitive pair trading.

Single-Asset Pair Trading

Single-asset pair trading can be applied to any asset, but is more commonly used for Forex and commodities. Single-asset pairs are executed pair-trades at different times but with the same expiration. This creates a barrier for the trade to minimize its loss and potentially double the income. The amount of investment and the expiration time must be identical for both trades for the strategy to take effect.

Let us apply this type pair trading using a Forex example. Imagine a trader has just executed a new call binary option trade on the EUR/USD currency pair which expires in 60 minutes. He places a $1000 investment and the opening price is 1.3308. The payout ratio is 75% for in-the-money result and the broker also provides an out-of-the-money refund of 15%. If he wins, he gets $750, and if the trade is unsuccessful, the broker provides a $150 refund.

Now, 45 minutes into the trade, underlying asset price stands at 1.3365 and the trade is currently in-the-money. But the risk is still there. With 15 minutes left before expiration, anything can happen. The binary options trader may be anxious that a price retraction could occur at that very moment until expiration time, causing him to lose 85% of his investment (100% — 15% refund). Breaking news may also cause a sudden drop or decline in the price. It is time to execute the second trade.

The binary options trader then purchases a put binary option, again using the same asset that he is trading on. The trader must use the exact same parameters that was used for the original call trade. Expiry times should be the same and the amounts wagered should also be equal. By initializing a pair, the trader would have produced a new window of opportunity between 1.3308 and 1.3365. If the trade expires inside this area, then a maximum profit of $1500 ($750 + $750). We have just addressed the first two advantages of this strategy as stated above.

For the third advantage, the binary options trader would have also minimized his risk exposure with the second trade that he executed. If the price closes outside of the win zone, or the area bounded by the strike prices of the two trades, then a specific, but significantly lower loss results from the trade. From our example, if the trader did not make the second call, and the EUR/USD closes lower than 1.3308, then he loses $850 (he gets back 15% or $150 of the original $1000 investment).

But, because he executed the second trade, the loss is significantly dropped from $850, to just $100. Let’s see why. If the price closes higher than 1.3365, then the first trade finishes in-the-money, and the second trade is out-of-the-money. For the first trade, the payout is $1750 (initial $1000 investment + $750 or 75%) while the payout for the second trade is $150 which is the 15% rebate. Add these two and we get $1900, or $100 short of the initial $2,000 investment ($1,000 for each trade). Therefore, the loss is just $100 compared to the initial $850 loss in the first scenario. This is also the case if the first trade ends out-of-the-money and it is the second trade that is successful.

Competitive Pair Trading

Competitive pair trading is also known as the Competitive Relative Value Trade strategy (CRVT). This kind of pair strategy was developed to take advantage of the price movements of two companies that not only operate in the same sector, but are in direct competition with each other. Some examples of companies that fall under this category include Apple/Samsung, Shell/Exxon, JPMorgan/Goldman Sachs, and others.

To put this strategy into context, let us take for example a binary options trader who learns about some a disappointing news release from Apple regarding a significant drop in their quarterly sales. This puts the trader in an inclination to trade against the stock. Now, he initiates a put option constructed on Apple’s imminent decline through the release, at a strike price of $467. The trader has chosen for the trade to expire in one hour and invested $1,000. Additionally, the payout ratio will be 75% if the trade finishes in-the-money, and the broker offers 15% out-of-the-money rebate.

Although the trader has placed the trade upon sufficient research, and with the backing of Apple’s announcement, the trade still carries a high risk. This is because the trader only stands to win $750 if the trade ends successfully, while he can lose up to $850 if the price moves against him. If the market is volatile, the trade could take unpredictable turns through its trade period. No matter how many years of experience a trader has, there is no guarantee that the trade will expire in-the-money.

With the competitive pair trading strategy, the trader can increase the odds in his favor by using effect made by the Apple announcement to a direct competitor. This part of the strategy now requires an in-depth understanding of the stock markets. This is because the trader needs to be aware of the companies that are most likely to benefit from Apple’s misfortunes. Market rival Samsung, for example, is trying hard to regain the market share it has lost to iPhones over the past few years. If background research indicates that the stock price of Samsung can appreciate at the detriment of Apple’s, the trader can initiate a call option on Samsung. Again, all trade parameters like expiry time and initial investment should be the same to see the effect of the strategy.

The advantages stated in the previous section are again addressed by executing the two trades. With the Apple and Samsung positions, risk exposure is reduced. If both trades end up correct, then the profit is doubled. The profit is also protected because one trade will always complement the other, making the trader safer in between their positions. Again, the risk exposure is $850 — $750 = $100, same as the previous example in the other pairing type. Similarly, this is far better than the risk of losing the original $850.

Why don’t you try out the pairing strategies in any of the recommended brokers that we have reviewed? You are sure to get excellent bonuses when you sign up with one of our partner brokers.

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