How many times has it been that you have your screen in front of you charting the trend, and it looks like a breakout in one direction is occurring! Unfortunately, it is not what you anticipated, and the trade you placed is working against you. You are so far out of the money that whatever value you had in the option is disappearing like lit gasoline. There is only “smoke” to remind you that there was at one time a binary option worth something a little while ago when the market was at its’ previous level. There is a strategy to play which can save your skin in markets. Consider far out of the money strangles with long time premium.
A Strangle means that you buy a call and a put at the same time but on different strikes equidistant from the current price of the underlying asset. Since they are far out of the money, their premium will be lower. However since you are buying with longer time value, most of the premium you pay is for the time value. Therefore as time decay occurs, there will be a steady, but small decrease in the price as each day passes the binary option is in your portfolio. The reason behind this strategy is that in the event the market turns volatile and turns in the direction of your call or put, then the option will rapidly increase in value making up for any time decay loss. Also the profit should more than cover the other side of the strangle because since you purchased so far out of the money, your initial premium paid was small.
The idea behind this strategy is almost like having property insurance on your house. We all know that the statistical possibility of your house burning is very small. Yet every year so many houses do experience fire, and we all have property insurance for that unexpected event. The risk of a certain “unexpected” event is transferred for that one of a kind drastic event. The same thought pattern can be applied to your trading. You are spending much time analyzing directions and market trends. Yet, there is always the possibility of directional risk. So the strategy to consider is the strangle especially if you place it successionally.
Gold is an example of a market where this strangle strategy could be very effective. It has been recently selling off hard lately dropping from its high of $1780 to approximately $1388 per ounce. After this type of drop, an out of the money call will be cheap to buy. You may want to consider it, but remember to buy far as far into the future as you can so that you won’t lose much on time value as it decays. Then if the market turns radically, you are set. If the market does not turn, the continued price movement to the downside will mean your put will make you the profit you need.