Binary Options Trading with Fence Strategy

Binary Options Trading with Fence Strategy

Submitted by adil on Thu, 03/12/2015 - 07:51

Traders use different combination of strategies in binary options to reduce the trading risk. Fence trading strategy is a type of a risk mitigation strategy that is used by the traders when they are not sure about the direction in which the market is likely to move.

How Does Fence Trading Strategy Work?

A trader has to buy a call option and a put option on the same asset with a certain exercise price to secure both ends of the market. In other words, he builds a fence to secure the ends. Therefore, you execute a fence trading strategy by purchasing the above and below options with the exercise price that lies within these options.

Example of a Fence Trading Strategy

It can be clearly understood with the help of an example. Suppose, the current price of an asset is $10, and a trader anticipates that the asset price will increase in another 15 minutes, and so he buys the “above” options for $50 that has a 70% payout and will expire in next 60 minutes. Now let’s assume that the market initially moves in the same direction as anticipated, and eventually changes the direction. As a result, the price starts declining. In this scenario, the trade will close out of the money if a trader doesn’t do anything. But if he uses the fence trading strategy, he will be able to reverse the situation and secure reasonable profits instead of suffering losses.

Now let’s take another example. Suppose, a trader buys a “below” option with the contract price of $100. The current asset price is $15 after declining from $20 a while ago. If the contract’s payout value is 70% and the expiry period lies between $10 and $15, the trader can still earn a profit of about $140 from both the contracts (above and below options). If the price of an asset ends up above $15, the “Above” contract will expire in the money and the “below” contract will close out of the money. But if the price of an asset closes below $15, a trader doesn’t make any profit on the above contract, however, he will be able to secure profits on the below contract and this contract will close in the money.

In this example, the advantage of using fence trading strategy is that no matter which contract closes out of the money, the loss is capped by $15, because the earnings from the winning contract will offset the losses of the other contract. If a trader had not implemented a fence trading strategy, he would’ve suffered a loss of $100.

When a trader plans to employ fence trading strategy as part of their trading plan, he must know that the success of this strategy is based on the strike or exercise price of a contract, because he trades two contracts with completely different duration of expiry, and these options carry a risk of expiring out of the money if the strike price is not right. Therefore, being a trader, you must always select the right exercise price in order to implement this strategy successfully.