Using hedging techniques with binary options

Unlike tradition forms of trading, binary options has the additional benefit of allowing traders to hedge their position. This allows binary options traders to purchase options both, long and short, on the same underlying asset. Whilst many may question how this form of hedging can be considered profitable, given that the likelihood is that only one position will close ‘in the money’, there are several ways in which traders can use this technique to both preserve capital and take advantage of profitable opportunities.

Preserving capital by hedging a position

Traders can use hedging a defensive method to prevent against losses where binary options have a very low likelihood of expiring ‘in the money’. Purchasing binary options in the opposing direction to options already purchased, as close to the original entry price as possible, can be a better way to preserve capital than using the close early function provided by many brokers. Positions which are hedged in this way will generally have one position close in the money and the other out of the money, allowing losses on the original position to be recouped.

Using defensive hedging techniques to increase profits

Using defensive trading techniques is only one way in which hedging in binary options trading can be effectively used to protect trading capital. Hedging can also be used to ensure profits on some of the highest probability setups and to effectively neutralise the risks inherent in binary options trading.

A good example of an opportunity to look to hedge a position is through trading range breakouts. Typically, when price spends a period of time within a close trading range, binary options traders will look for price to ‘break out’ in either direction to provide high-probability trading opportunities. Purchasing options in the direction of the breakout, using the positive momentum created by price moving out of the range, is ideal for short-term binary options traders to generate profits. However, whilst these breakouts are often genuine, they occasionally form a ‘false breakout’ where price reverses shortly after appearing to break out of the trading range. Binary options traders, however, can mitigate the possibility of losses by hedging their original trade when price reverses and returns to the initial entry price. This effectively neutralises the trade or at least reduces losses on those break out trades which fail. The fact that break out trades offer a high probability of success limits the requirement to hedge these but it offers an excellent insurance technique against losses in these trades.

Good entries are critical for hedging positions

Hedging offers an excellent opportunity to cut losses and run profits for binary options traders, however, it still requires that binary options are purchased as close to the strike price as possible to avoid the risk of both positions closing out of the money. For this reason, hedging is perhaps most effectively used when a momentum trade begins to turn negative and a trader is willing to take immediate action to avoid incurring losses.