Trading Gamma using binary options allows traders to risk a small amount for a higher reward, if price moves in their direction. High gamma binaries are easily recognizable because there will be just a few strikes trading and can be seen within the strike premiums. Here is an example.
Trading Gamma Using Binary Options
Gamma typically increases when the markets are moving slowly because only a few strikes will be actively trading. For example, last night on the Japan 225, the markets were moving slowly and a reversal bar to the downside formed (red arrow below). This indicated more downward movement was to be anticipated.
The risk on the trade was $28.25 per contract and a potential reward of $71.75 per contract (excluding exchange fees).
Now let’s examine the difference between the low gamma strikes (lots of strikes are available and market is active) versus high gamma strikes (fewer strikes available and market is slower). The first image shows the USD/JPY 6am – 8am binary options, which is very active and has many strikes available. The bottom image highlights the active strikes that were offered on the Japan 225 last night for the 7pm – 9pm expiration. Notice on the USDJPY, there are more than seven strikes currently being traded. However, on the Japan 225, there are only three. Now zoom in on the differences between the strike prices to sell. On the USDJPY, there is a difference of about $7 to $8 between the different
The bottom image highlights the Japan 225 last night for the 7pm – 9pm expiration, which has only a few strikes available and the market is moving slowly. Notice on the USDJPY, there are more than seven strikes currently being traded. However, on the Japan 225, there are only three. Now zoom in on the differences between the strike prices to sell. On the USDJPY, there is a difference of about $7 to $8 between the different
On the USDJPY, there is a difference of about $7 to $8 between the different sell strike prices. Another way of looking at it is the Gamma between the sell strikes is about $7 to $8. Compare that with the Japan 225. The difference between the sell strike prices is about $30 — or a much higher gamma.
Compare that with the Japan 225. The difference between the sell strike prices is about $30 — or a much higher gamma.
Low Gamma Strikes (USD/JPY 6-8am expiration)
High Gamma Strikes (Japan 225 7-9pm)
In other words, a small movement in price can result in large rewards. In this case, the trader is risking $28.25 to make $71.75 (excluding exchange fees) or a risk to reward ratio of $1 to make $2.54. The downfall for trading high gamma is that probabilities are against the trader. However, since the price bar was indicating more downward movement and the market is in a downtrend, the path of least resistance was down. At expiration, the indicative price index was 19535, which was less than the strike price at 19540.
As shown above, high gamma trades are easily recognizable by simply looking at the price differences between one strike to the next strike. If the market indicates a move in one direction then trading gamma using binary options to limit the risk is an ideal trade setup for a higher reward trade.
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