Welcome to our Options Trading Tutorial. Options trading is all about understanding leverage and trying to get the highest return investments to pay out in the shortest amount of time. You'll find that in this tutorial we delve into other related topics where leverage is important in order to improve your understanding of why options trading in most cases offers a better trading experience than other forms of trading.

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Options Trading Basics | Call Options | Put Options | Carry Trade | Inflation Investments | Option Brokers | Making Money on Options
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Wednesday, December 14, 2011

Binary Options Hedge vs Trading Barrier Options

Are Barrier Options the Right Choice for You?
Before one considers trading barrier options one should also consider the similar alternative investment, the binary options hedge. Although the investments are very similar in terms of in the money yields offered, the risk characteristics are considerably different. Many times the determining factor in deciding which asset to trade comes down to a choice of convenience versus control.

"The development of binary options trading has been a huge blessing for the world of hedge trading for retail investors," said Steve Wise of binary-option-broker.com. "It affords the retail trader the opportunity to make simple hedges in the marketplace as a means to trade for profit or as insurance against loss. Previously this sort of risk management trading was the realm of institutions and wealth managers."

Convenience vs Control

Wise added that when it comes to picking barrier options or attempting to use the binary options hedge it really came down to a choice of convenience or control. "Does the retail trader want to buy a spread of values outright with barrier options or does the trader want to have more control over when - and whether - an individual binary options contract is left open or hedged. The effort required to do either trade and the range of potential outcomes is considerably different depending on which contract you decide to use."

When a trader picks up a binary options contract with the intent to potential hedge the initial contract with an equal and opposite trade, the resulting combination of assets provides a small range of strike prices with a high yield of sixty to eighty percent and a very wide range of values with a modest loss - "Typically ten percent plus or minus," according to Wise. In theory the draw of opening one contract and then hedging it revolves around having the opportunity to create a window of values with a high yield while all other possibilities preserve most of the capital invested.

Boutique Solution vs Off-the-Shelf

On the other hand in the case of barrier options the retail trader effectively walks up to the counter and picks up whatever spread of values is offered by the barrier options broker. Said Wise, "The range of in the money expiration prices is set by the broker at purchase and the day trader then hopes the contract expires with the spot price somewhere in that money range." Once the contract is purchased, the trader effectively walks away having already bought both the put and calls at the same time. One major difference with the binary options hedge is that the tail risk - the possibility that the contract expires outside the money - results in loss of most or all of the investment. "In theory the tail risk is the price the trader pays for the typically wider spreads and convenience of buying a range of values with no initial open ended exposure," said Wise.

Regardless of whether a trader has an interest in barrier options or binary options it behooves them to take a basic options trading course to learn the ropes according to Wise.