The simplest form of binary options trading is to purchase a call option if you expect the price of your chosen asset to rise by a set time or to go for a put option when you think the price is due to fall. However, sometimes the situation may change after you’ve made your first trade and you may decide your initial position is wrong. In this case, you may purchase a both a put and call option to minimise the losses. This is sometimes known as a spread strategy.
Purchasing both a put and call on the same asset is a means of limiting your losses if things don’t go as expected. For example, you may stake $100 on a call option for a particular stock that currently has a $10 price, expecting it to go above that level by the end of a two hour period. After an hour, it stands at $10.50 and so you seem likely to end up in the money. However, you hear news that the company in question has lost a big order, which will have a big impact on its profits and so is likely to send the price of the stock down.
The effect of this is that the price may drop below the initial $10 level and, if it does this within the next hour, your trade will fail and you’ll end up out of the money. To counteract this, you can purchase a put option on the same stock for another $100, meaning your total stake is now $200.
Limiting Losses
If your original trade had finished in the money, you would have received a typical payout of 75% and ended up with a total of $175 including your original $100 stake. However, if the price had fallen you might have ended up with nothing. Having purchased both a call and put option for a total stake of $200, you’ll now be in the situation where one trade will end up in the money and the other will fail, depending on which way the stock price moves. The outcome is a $75 payout on one trade and the return of your stake, with the other resulting in the loss of your $100 stake. You will therefore have $175 from your original $200 and so have limited your loss to $25 instead of the $100 that seemed likely.
Placing both put and call options when a trade starts to go wrong is a good hedging strategy that will minimise losses.