Range Binary Options
Binary options are a form of instrument which give the buyer a set cost and payout on a set prediction on whether the price of an underlying asset will move up, down, or sideways, in our outside one or more specified levels. Trading binary options can be profitable when utilised in certain market conditions, though do not always offer better value over trading straight forward spot markets. For those new to the world of binary options, the variety of different types of binary options available may seem complicated or hard to understand. These pages are dedicated to explaining the differences between the various types of binary option. It is just as important to choose the right binary option type is it is in picking the right binary options broker.
In this section we will take a look at range options.
What are range options?
Range options are used by binary options traders when speculating whether an asset will stay within a specified price range over a certain length of time. This type of option is also known by a number of different names, including boundary and tunnel options. To achieve a payout with a range option, the price of the underlying asset needs to stay between two given strike prices (or barriers) over the period of the contract (the expiry period).
How range option trading works
Range option trading has become popular with traders, as they can offer high returns in a quiet or stable market. It is worth noting however, that not all binary options brokers offer this particular type of option. The basic principle behind this type of option is quite simple, but in choosing when to use it and whether it offer better rewards to traditional range trading in FX is the hard part. Not to worry, though, as we will aim to cover all aspects and their advantages and disadvantages. Let us look at the basic structure and explain how range options trading works.
As above, we have stated that a range option is one which looks to profit from an asset price staying within a price range over a set period. First, the trader decides on the limits of the range he believes the underlying asset will stay inside and set the barrier levels accordingly, then he will set the time – or expiry date he believes it will be achieved in. In the retail market, the range prices or limits will usually be fixed by the broker, ie they will offer a number of choices to the ranges one can trade. As with all other binary options trades there are only two final outcomes. The option is either ‘in the money’ or ‘out of the money’. If the price of an underlying asset remains within the specified price range, the option is ‘in the money’ and the buyer will receive a payout determined at the outset. If price moves outside or breaks the set range, then it is ‘out of the money’ and the buyer receives nothing, losing the premium paid for the option. As we will see in other structure, discussed on other pages, brokers can also offer out-of-range options, which will profit if the price breaks out of the preset range within the time or expiry period of the option.
For now, it is clear that if a trader believes an underlying asset is about to enter a quiet period, he can choose to try and profit from this with a range option and depending on the limits set, can achieve a healthy return. This depends on the range set however. If the trader chooses a tight range, then the payout will be higher in percentage terms as the contract will have a higher chance of being breached (or broken). The wider the limits, the less chance of it being breached, so the amount of payout will be lower. It all depends on where the trader decides to set the range.
As such, if the trader does not believe the payout offered by a certain range is enough to justify the risk – in this case the cost of the option (the premium) -, then he/she will be better off with trading the range in the spot markets, setting his stop loss against the limits he would choose either side of the market. There is no premium to be paid, and the trader will also have the freedom to exit the trade at any time, freeing up capital for other opportunities or trades which may come up.
As attractive as some of these options and their payouts may be, traders will have to consider the premium they pay and how much of their capital (trading amount) is tied up on one trade.
There is also one other factor to consider and that is the triggering of limits. It is not unknown that the market can push for certain levels to look for orders. Buying a range option can leave a buyer vulnerable to irrational spot moves, so trading straight forward FX also offers a more flexible approach with this in mind.
AN EXAMPLE OF RANGE OPTIONS TRADING
Using an example is always easier to understand a concept so below is one to show the process and reason for trading a range option.
A trader is focusing on the price of Apple stocks, which is trading at $500 (for example is not a reflection of the real market price). The company’s quarterly returns are about to be announced and he/she believes they will fall as analysts have forecasted. The trader may believe the stock price may fall a little, though the move will be relatively small and remain overall little changed. Your binary options broker offers a range option with a price range of between $485 and $515 and a set payout should price hold this range. The trader can buy this option in the belief that Apple’s stock price will see little change and hold is price over a set period. In paying the broker for this option, if price behaves as the trader expects, the option will pay out a preset amount. If it breaks the range, the buyer receives nothing and he/she loses the premium paid to the broker for the option. As we can see, there are clear risks, and as attractive as the payout can be, there is clear risk in losing the amount paid for the option. The trader will have to determine whether he/she sees value in committing capital to a trade which can come to nothing.
Should the trader decide that the payout is not worth the risk, then trading the underlying stock price after the data has been released can offer a better risk to rewards and also give him the flexibility to trade at any time. Once the option is bought, then it is a case of ‘sit and wait’.
Tips on how to trade range options successfully
If you think that range options are for you, then keep reading, because we’re about to share some important tips. After all, you must be interested in any advice on how to become more successful, surely.
- Keep up to date with the latest financial news. Our example above clearly shows the importance of keeping abreast of company financial affairs – otherwise you’ll only be guessing.
- Consider trading outside the range, – too narrow too risky, or too wide to offer a decent payout?
- Also consider the time of the contract and the amount of risk you have to contend within that (expiry) period.
- The expiry period may also be a considerable amount of time to tie up capital, so maybe it is better to take advantage of trading the underlying asset to give yourself greater freedom and flexibility.
- Spread the risk with a number of smaller range options.Paying less for a range option and choosing more than one range contract is an populair with some traders, but the risk levels are the same.As with all types of trading, the general rules apply. It is always important to stay focused, and use what you have learned to get the best from your trading strategy. Having an understanding of range options will help you understand what is out there on offer, but as ever, you will have to weigh up the benefits against the costs to determine whether they are better form of trading than straight forward Forex – or any other asset class you choose to trade.