Trading binary options involves using a number of indicators and other elements as well as being aware of the sentiment in the market place. Some strategies will be suitable for traders with little experience. Traders who have more experience tend to adjust and fine-tune the basic strategies to suit their particular style of trading. Each strategy has a risk to return profile that differs from other strategies and traders need to be aware of these.
The Straddle Strategy is used when a trader thinks that the price of the stock he wants to trade will move, but he can’t decide which direction it will take. Because trades are put on both directions, the move has to be big. If it is not big, there will be little or no profit.
The Straddle Strategy is high-risk because if the stock moves a little in one or other direction, the investor will suffer a loss. Another factor to consider is that where the market feels that a stock is going to make a big move, the price of the option rises accordingly. The higher premium reduces the profit that can be made on the trade if it does make a big move.
Types of Straddle Strategy
To perform the Straddle Strategy a trader places identical trades to cover two scenarios: If the stock gains in value and if the stock loses value. The trades will be for the same value and have the same strike price and expiry dates and times.
In detail, the strategies look like this.
Long Straddle Strategy
When the markets are volatile, traders predict that prices will move a lot, but they are not prepared to predict the direction. They will use the Long Straddle strategy. They will buy a Call in case the prices rise and a Put in case they fall. Both trades have the same strike price and expiration date. In this way they are covered, which ever way the market moves.
When markets are not volatile, traders resort to the Short Straddle. Here they sell both a Put and a Call with the same strike price and expiry date. The profit a trader makes from this trade is derived from the premium. If the markets change character and suddenly move a lot, no profit will be made on the Short Straddle.
In binary trading, traders have one of two options — they can trade a Call or a Put. These options are more likely to result in profits in a volatile market, so the Long Straddle is used more than the Short Straddle.
Example and Tips for Straddle Strategy
Let’s look at an example of the Straddle Strategy. Say the stock we are interested in is trading at $60. We will buy one 60 Call at, say $150. We will also buy one 60 Put at $150. The total trade is $300 which means we are exposed to a maximum loss of $300. We will lose $300 if the price remains at or returns to the strike price of $60 when the trade expires. There is no limit on the profit that can be made on this trade because it is not limited by the price having to move up or down. We are covered for both eventualities.
The Straddle Strategy covers the trader for a rise or drop of his selected stock, which makes it an attractive trading method. It is best used when it appears that the markets are transitioning from a quiet period to a more volatile period. It is less effective if the markets are already volatile. It is also best to close the trade if you see that there is volatility in the market but the stock you have traded is not responding in the same way — in other words, it is staying relatively static.
The Straddle Strategy is also best used on a more sophisticated trading platform that allows pending trades to be set up. In this way, the trader can decide that if his selected stock reaches a specific price, then he would like to place a trade. He can then place the trade so that it only triggers and becomes active if that price is reached.