Combination strategy using spot and Nadex binary bull spread

If we begin by considering the two components in isolation. First we have a spot position, where we have entered the market at 1.3200 with a stop loss of 100 pips below at 1.3100. For such a large risk, we would expect to be looking at a substantial move in our favor, perhaps over days or weeks. Here however, we are considering an intraday position, and one where we would normally place any stop loss perhaps 20 or 30 pips below, and in line with an expected move in this timeframe.Moving to the binary bull spread.

Here we have sold the option at 1.3185, 15 pips below the ceiling. This is the ‘protection’ we have purchased. You can think of this as a premium on the position – it’s the cost of the insurance if you like. In marrying the two approaches, our purchased protection becomes our maximum risk. It is the cost of the position, and in addition has allowed us to increase the depth of our stop loss giving the position room to breathe. In a way, we have bought ourselves time.

Time to allow the position to move into profit, remembering that we can always close out either or both whenever we like. In addition, in overlaying these two approaches we have also opened up the risk reward profile, having moved from the fixed risk and fixed reward of the bull spread, to fixed risk and unlimited reward with the addition of the spot position.

And there is a further, perhaps more subtle reason for adopting such a strategy, and it concerns the stop loss. If you were trading this as a simple intraday trade to the long side, any stop loss would probably be placed to within 20 or 30 pips of the entry price. By introducing the bull spread our stop loss has moved much deeper, but with no equivalent increase in risk.

We are now in a situation where the market can move against us in a meaningful way, but the position remains intact. We have bought ourselves time for the position to breathe, and potentially move into profit which would probably not be achieved with a conventional stop loss. A conventional stop loss set close to the entry is always at risk. It is a subtle point, but one that is often lost when considering this strategy.

Furthermore, if the position moves in our favor to expiry, further spreads can be added against the position with an associated move in the stop loss, allowing us to manage the position further.It is important to ensure the binary spread is matched to the spot position. If you are trading a full lot at $10 per pip, in the above example you would need to sell 10 contracts to equate to $10 per pip in the option.

And here are the possible outcomes, using a full lot in the spot market:
The spot market moves to 1.3250 at expiry:
Profit in the spot market = 50 x $10 = $500
Loss in the bull spread option = 15 x $10 = ($150)
Total profit = $500 – $150 = $350
The spot market moves to 1.3140 at expiry:
Loss in the spot market = 60 x $10 = ($600)
Profit in the bull spread option = 45 x $10 = $450
Total loss = $450 – $600 = ($150)

The spot market moves to 1.3210 at expiry:
Profit in the spot market = 10 x $10 = $100
Loss in the bull spread option = 15 x $10 = ($150)
Total loss = $100 – $150 = ($50)
The market could collapse and trigger the stop loss at the floor of 1.3100, but even so the maximum loss would once again be the ‘insurance premium’ you have paid to protect your position, as in this case the binary spread would be in profit at $850 against a loss in the spot market of $1000.
Considering the first outcome, you may be thinking you have had to forego $150 of potential profit, mak

ing only $350 against a possible $500. Whilst this is certainly true, this opens up the debate surrounding trading emotion, and the stress you would feel trading a position which was moving heavily against you. Which of the following scenarios would you rather have?
The prospect of $1000 loss in your account
The prospect of $150 loss in your account
The prospect of a reduced profit
The prospect of a very small loss
If you are a seasoned trader with years of experience, you may be equipped to deal with this pressure. However, if this were your second or perhaps even a third

losing trade, the pressure is not so easy to handle. Insurance always comes at a price, but in using this strategy, you have not only bought yourself time, but also a certain amount of peace of mind.What this strategy does is to define the risk on the trade. If you are keen to trade other markets such as commodities, or perhaps have come from the futures market, and familiar with the margin requirements for oil or gold on the full size contracts, you will already know the amount of margin that is required, simply to manage your risk and position. Using this strategy will give you the tools to trade more comfortably, and with a clearly defined level of risk. Nadex offer this very simple option across all the markets and they are available throughout the trading session.