Boundary Binary Options Trading
There are a number of different ways in which you can trade binary options on forex. The most common type of binary ‘play’ is to trade the direction of the underlying asset and bet on whether price will be above or below a predetermined level. The name of this type of options trade is up–down, or a call–put option, and we shall look at these options on another page. This is the type of trade that many traders choose to start with before moving on to more complex options. In this section, we will focus on boundary options, also known as range or tunnel options.
What is boundary options trading?
Also known as tunnel or range options, boundary options are used to forecast whether an asset price will remain within a predetermined range. Naturally, and an upper and a lower level are set either side of current market, and in order to receive a payout, the asset prices must stay within the ‘boundaries’. There are two types of boundary trades. Traders can either choose to bet on whether price will stay within the limits, or whether it will break outside of the range or boundaries. If the trader believes we are in a stable market, then he or she can use this type of option to benefit from an expected low level of activity or low volatility within the boundaries. In a more volatile market, the trader may expect price to trade outside the boundaries and will set terms accordingly with predetermined limits.
How boundary options work
Boundary options allow a trader to express their view on the volatility of an asset and/or market, and these structures have a greater advantage when times are quiet. As a result, directional trades are less likely be successful, so these options give a trader an opportunity to profit from limited activity by predicting whether an asset price will stay within the confines of a predetermined range. Here is an example;
If you believe that the stock price of McDonald’s will trade between $9 and $10 over the next month, you can choose to buy a boundary options contract with limits, sometimes referred to as barriers, set at $9 and $10, with a 1 month expiry date. Over the course of the month and when the contract expires, if the price closes within the limits set a $9 and $10 respectively, the option will pay out a set amount agreed at the time of initial trade. Should the price break outside of either side of the limits set, then the options contract will expire worthless and no payout will be made. In this instance, the cost to the trader will be the upfront premium or price of the option, paid by the trader.
Conversely, boundary options can also be used to take advantage of expected volatility in the market, and when the trade cannot decide on how the direction will play out. In this case, the trader will look for price to trade or break outside of a predetermined range. In the example above, should you decide that the price will end above or below the $9–$10 range (or boundaries), your options trade will earn a profit as long as it breaks or moves outside of the predetermined range.
If the boundary option is a European style option, then the price of the underlying asset has to be inside or outside the range set, at the end of the expiry date to earn a payout. An American style option means that if the price stays or moves outside of the range at any time during the expiry period, then payout or closure will occur. American style options are therefore more expensive to buy than European options.
As you become more familiar with the different types of trading options, you may consider using boundary options as part of your overall trading strategy. Naturally there are times when volatility is low, and prices are moving in tight ranges. In this instance, boundary options are an effective way to express the view that this is set to continue. If you think volatility is set to rise, but are not sure which way the price, or market will turn, boundary options are also an effective way to capture prospective moves in the market.
However, it is worth noting that these structures will not offer the best opportunities all the time. One has to judge the state of the market, and in some cases, when volatility is set to rise, one can earn greater profits using straightforward buy or sell, (long or short) positions in the underlying assets. It is worth remembering that when volatility is high, the price of these options contract can push higher, and will therefore offer a better alternative in the ‘spot’ markets.
What are the benefits of trading with boundary options?
There are a number of benefits to trading with boundary options, and will focus on the more relevant ones to and for you to consider. Setting out the benefits will the help you know how and when to trade these types of options if you wish to do so.
As mentioned above, boundary trading gives the trader the flexibility to trade to and increase profit potential in all types of market conditions.
A trader is given the choice of setting a range or limits which he believes the price will remain inside of. As a result, the trader can also look to profit from quiet markets, such as over the summer or over other holiday periods – perhaps even when there is little data to trade off.
The trader will pay a set amount agreed at the outset. If the strategy pays off, then the trader will receive a payout over and above the premium paid. If not, his or her losses will be confined to what is paid initially – that’s it.
Why trade with boundary option types?
As we can see, there are a number reasons why it is beneficial to to trade with boundary options. However, given that the market conditions change continuously, it is better to use these structure as part of your trading strategy. There are times, when trading in the underlying assets will offer better potential results and increase your risk-reward ratio.
Boundary options are a relatively easy concept to understand. After a becoming accustomed to its uses in certain markets, your decisions will be better based and this should lead to greater success. Boundary options, just like their underlying assets are influenced by the same developments in the markets, so it is still important to keep in touch and up to date with the latest financial news. They do not offer an easy way around to trading the market without the usual monitoring of day-to-day events.
We will feature a number of brokers who offer boundary options, along with some of the relevant reviews.
Whether markets are volatile or quiet, boundary options can be a great way to trade and increase your chance of success in certain market conditions. We do however consider their use better as part of a trading tool-kit (if you like). Trading in the underlying markets can offer better opportunities – some would say, more of the time. Even so, it is another instrument to help you express your views in the market, and with time and experience, their uses will become more apparent.
Stick with us, as we’ll be bring you plenty more information to help you understand binary options and whether they can be of use to you in your trading strategy – with the ultimate goal being your success.