BSZ Options Range Strategy Risk and Reward Profile

As we can see, provided the index closes between the two strike prices the profit is $650, but anywhere outside of the range specified the option closes at a loss of – $350. As with all binary options, it is the all or nothing proposition which defines the precise limits of the risk and reward profile.Whilst I have used an on exchange binary option to explain this strategy, it is one which can be applied equally well to Nadex binary options and to off exchange options too.

The risk and reward profile is the same, and all we are doing in creating the range is applying our knowledge of the underlying market to define this ‘range of expectation’ for the construction of the position. It is a stress free way to trade, and in addition is entirely flexible allowing risk and return to be balanced and matched to the underlying sea state conditions precisely. Employing this strategy on the Nadex platform you will be spoiled for choice.

This strategy can be extended further by considering cross instrument hedging, either in the same market such as forex on other pairs, or in related markets where correlation plays a part. And remember with the Nadex platform you also have the additional flexibility of closing out early to take profits off the table, something which may not be available off exchange.

Staying with Nadex here I want to explore the Nadex bull spread option product, once again, but here we are going to combine the binary option with the underlying spot market to create a simple hedging strategy. Before constructing the hedge, I would like to clarify the terminology. What Nadex refer to as the ‘bull spread’, is perhaps a little misleading, and I believe Nadex will be renaming this product the ‘Nadex spread’ in the near future.

Perhaps the easiest way to think of these instruments is as a box on the chart with a defined floor and ceiling. The spread is the difference between these two levels, and it is important to appreciate from the start, this instrument is not the same as the binary option in terms of the expiry. It still has a fixed risk and fixed reward profile as we saw earlier, but settles at the underlying market, and not at 0 or 100.

This is a hybrid instrument, which draws together elements of the binary world and elements of the vanilla options world. In this case the instrument settles to the underlying spot market and not to the traditional zero or one hundred of other on exchange binary instruments.The options can be both bought and sold, and are quoted across the complete range of markets for indices, commodities and currencies.

The floor and ceiling (the strike prices if you like) are defined by the exchange and not by you as the trader. This is a key difference, because in the vanilla world, you create the two strike prices and the two legs. Nadex have made this very simple by creating the instrument for you, thereby negating the need to construct the two legs of the position yourself.This is an example based on a 2 hour expiry for the EUR/USD. The bull spread option will be quoted in the following way:

The spread – in this case 1.3100 to 1.3200
The expiry date and time – in this case 2 hours

Here the spread is 100 pips from the floor of 1.3100 to the ceiling of 1.3200 with a 2 hour expiry period. The box confirms the start and the finish, with the floor and the ceiling defining the top and bottom of the box.
If you were to sell this spread at say 1.3190, the risk and reward profiles would be as follows:
Maximum risk = 1.3200 – 1.3190 x $1 = $10
Maximum profit = 1.3190 – 1.3100 x $1 = $90
Even if the market moves below 1.3100 before or after expiry the maximum profit is capped

Even if the market moves above 1.3200 before or after expiry the maximum loss is capped
The option can be closed at any time before expiry or left to expire
If you were to buy this spread at say 1.3110, the risk and reward profiles would be as follows:
Maximum risk = 1.3110 – 1.3100 x $1 = $10
Maximum profit = 1.3200 – 1.3110 x $1 = $90
Even if the market moves above 1.3200 before or after expiry the maximum profit is capped

Even if the market moves below 1.3100 before or after expiry the maximum loss is capped
The option can be closed at any time before expiry or left to expire
Now let’s look at applying the above example to a spot forex position.
Suppose the EUR/USD is trading in the spot market at 1.3200 and we are bullish, and trading a full lot contract. In other words each pip in the spot market is + or – $10, so we buy at 1.3200. We are going to add the binary bull spread with a floor at 1.3100 and the ceiling at 1.3200, and sell at 1.3185.