Protection from market spikes

July 23, 2014 04:58 AM

Equities had a quick downward spike last week and while many traders may have profited, no doubt some lost money.

A market spike is a large upward or downward price movement occurring over a short period of time. There are a few ways for traders to try to minimize risk when a market experiences a spike and one way is with binary options.

Binary option contracts are simple yes/no questions that allow the end user to take a position in a particular market because he thinks price is moving in a certain direction, or because he thinks a certain upcoming event will cause the market to move in a certain direction, in a specified timeframe.

In traditional trading, market spikes can force your positions to close. This is known as being 'stopped out' and can occur when a stop order is triggered or when there is insufficient margin to keep the position open.

Binary options offer traders protection against getting stopped out, even if the market spikes against them. Also, their risk remains capped throughout.

Placing a stop order can significantly reduce your risk on a trade. However, in some cases your stop can be triggered, only for the market to recover and reach a level where your original trade would have been profitable. And with sharp spikes, often there will be additional negative slippage when getting stopped out.

Binary options can protect you from market spikes.

With Nadex, the price of a trader’s contract always remains between the floor and the ceiling, so you know your maximum potential profit or loss in advance. Unless a trader chooses to close his position early, it always remains open until expiration. You never get stopped out no matter how much the market moves against you.

And you can never lose more that your initial collateral. There are no margin calls and your risk is always capped. No slippage.

Let’s look at an example in crude oil.

Imagine the price of crude oil opens at just over $90.00 and you think it will increase by the end of the day. 

Nadex Crude Oil > $90.00 (4:00PM) is trading at a bid/offer of 48/52 so you buy at 52.

The underlying price of crude oil then falls significantly and the bid/offer for your binary option drops to 0/4. Your contract has reached its maximum potential loss but you haven’t been stopped out, which could happen with traditional trading.

The market then rebounds upwards in your favor to finish above $90.00 at 4 p.m. The price of your binary option also climbs and settles at 100 at expiration. What could have been a losing trade with traditional financial products is a profitable trade with binary options—in this case, Nadex binary options.

Remember, you can close your position at any time to cut a loss or take a profit. You do not have to wait until expiration.

Let’s look at a timelier example for last week in the E-minis.

If you had a neutral to bullish outlook and wanted to take advantage of the added volatility from geopolitical concerns you may have bought a weekly binary option to close at or above the previous week’s close of 1962.50. On straight long futures, you would have most likely been stopped out on Thursday’s downward spike when the E-minis dipped to 1948.50. Your outlook was proven correct when the market rebounded on Friday to close 9 points higher for the week. On a straight futures play you would have faced too much heat to stay with a long position, with binaries you can maintain that opportunity.

No trader is right all the time so it’s important to maximize your gains when you are correct. And when you can’t predict a market spike, it’s important to be able to prepare for them. Binary options help make that simple.

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