Hedging a Forex News Risk Event Using Binary Options

In the past few days I have been writing all about how excited I am about my Forex hedging strategies using Forex binary options. If you have read my previous posts on this blog, then by now you are familiar with how to hedge a breakout of a Forex instrument using binary options. But just to recap, binary options hedging offers a better alternative to traditional stop-losses. The reason they protect you better than stop-losses is that stop-losses lose money when they are hit and a binary option hedge does not.

Its that simple, The principal behind this is that binary option hedges shift the risk from below the breakout point to above it. The most attractive feature of this risk-shift is that trader momentum works in your favor above the breakout point. Have a look at my previous posts if this is not clear.
Today I will talk about another binary option hedging strategy. This strategy is similar to the strategy we have been discussing. The only difference is that the timing of both your Forex trade and your binary option hedge will be based on a a rally following a Forex news risk event, rather than a breakout of a resistance point.
In this example, today Great Britain released an important news data, the CPI y/y. Immediately after the news release, which attested to a better than expected rise in Great Britain’s CPI, the GBPUSD rallied as expected. Just after buying a long position on the GBPUSD, I placed a binary option hedge on www.Tradesmarter.com ’s binary option trading site. As in my previous posts about hedging, this hedge was a position opposite to the Forex position that I was holding, in other words a $100 PUT GBPUSD binary option trade. What this effectively achieved was to provide me with a $70 buffer zone below the breakout point. Anywhere within that buffer zone, within a $70 loss on my long Forex position, I would have been protected against a breakout failure without losing any money. A stop-loss, on the other hand, would have resulted in losses in case it was hit after a breakout failure or a shake-out (a minor test of the breakout point).
We have been talking about trader momentum as an important element in making this strategy successful. As you can see in the image and in examples in my previous posts, as long as the breakout failure is minor, selling momentum will be minor in my hedged buffer zone, just below the breakout point. As soon as the breakout re-occurs after testing the breakout point, trader buying momentum will work in our favor by quickly providing us the gains we need to cover the cost of the binary option hedge, $85.
In short, trader momentum works in a highly correlated nature with binary option hedging. This makes binary option hedging a more successful strategy for protecting against minor breakout failures than a traditional stop-loss.

Go to trade options

Trade Binary Options as a Hedging Strategy for Forex Trading

Forex traders often encounter failure of their strategies in the dreaded stop-loss zone. This zone, adjacent to the breakout point, is the fuzzy area where we Forex traders often place stops to protect ourselves from further losses. Each Forex trader who trade options uses different rules for his stop loss point. Usually this is slightly above or below the breakout point. But as we have all experienced, the problem is that a breakout often tests the breakout price, sometimes dropping slightly below the breakout price, ’shaking us out’ of our trade. Therefore the stop-loss point becomes fuzzy, forcing us to choose lower and lower stop-loss points, and wearing us out each time we re-enter the same breakout point.

Trade Binary Options using Binary Hedging Strategy

One attractive possibility is to hedge our Forex trade using a binary option hedge. This is actually much simpler than it sounds. What it actually does is shift our risk from the stop-loss zone to the area above the breakout point, where the prices are more likely to rise and where the breakout is less likely to fail due to the properties of trader momentum.

• Here we outline one such hedging strategy, using binary options trading to hedge against our Forex trades.
  In this example, i place a trade of 1 mini lot EURUSD long, when its price crosses my breakout point of $1.00. Should the EURUSD test my breakout point before i exit this trade, i will place a $100 PUT binary option trade. What this does is shift my original breakout point lower, similar to a stop-loss, such that i am profitable as long as a test of the original EURUSD breakout point does not leave my Forex account with greater than a $70 loss. If I incur more than a $70 loss in my Forex account, then I immediately exit the EURUSD position.

• This has effectively shifted the risk of breakout failure from the below the breakout point to above the breakout point. The attractive feature of this hedging strategy is that most breakouts are often tested slightly the below breakout point. Using this hedging strategy we protect ourselves in the area below the breakout point rather then get worn out using a stop-loss that is lower than the breakout point, which is the common Forex trader practice. And the best part of this strategy is that the risk has been shifted to the area above the breakout point (our Forex trade must make at least $85 profit in order to cover the binary option loss). However we know that as long as the breakout has not failed, we will more than likely cover this hedge. Remember, the breakout is most likely to fail BELOW the breakout point, but now we are covered.

About the author: Jack Major is currently the Chief Risk Management Office of  TradeSmarter.com, managing Risk and Strategies for all major market instruments. Previous to TradeSmarter, Jack was a senior consultant for many years for PricewaterhouseCoopers Global Risk Management Solutions division.