This article can show you the advantages of hedging call options by using binary options, as well as explain you how it works. Binary options offer a fixed payout, which can be used effectively for hedging risks associated with other options. Call options guarantee their holders the right – but not the obligation – to buy a security under predetermined conditions (conditions pertaining to the amount, price, time frame etc.). The put option is the counterpart of call option. Generally speaking, call options are only profitable as long as the strike price is lower than the underlying price. If not, the option is practically worthless, so holders often find themselves in need of some kind of insurance against this – something that will guarantee a stable positive payout if the underlying price increases. This is where binary put options come in.
How to hedge call options?
In order for binary options hedging to work, you need to figure out three things: the number of binary options you need to cover the long puts; the number of binary options it takes to cover the cost of hedging and account for additional binary options will you need in case you have to adjust the final price. After adding up all three, you get the total number of binary options you will require for hedging. Just remember to make sure your binary options profit can cover the costs of the endeavor, if not – you need more options. If everything goes right, the binary options will keep you covered until the underlying price gets as high as you planned. At that point, your binary options will expire, but on the upside, you will have earned more than enough on your long call options so won’t care a bit. If not, well, as stated previously, the binary options got you covered.
By acquiring a sufficient number of binary put options to counter the risks of your ordinary call options, you can avoid unnecessary risks. By betting against yourself just enough to cover any losses, you effectively remove all risks from the equation. The way this works is that if you combine enough binary put and ordinary call options, you can cover both potential outcomes. The profits on your binary options will cover all costs incurred during the investment, so you literally cannot lose.
There are two possible outcomes: either the underlying price goes below the strike price, or it doesn’t. In the first case scenario, your binary put options will cut your losses automatically. The call options you acquired will be worthless, but since you covered your rear, the fixed profits from little “insurance policy” will save you from any losses. In the second case scenario, however, your binary put options are worthless, but the ever-rising payout from your call options will cover any losses you’ve made – and then some! After all, that was the whole idea. Cash out on long call options and have some well-earned fun.