Calling Market Tops & Bottoms Using Binary Options
This post was written by James Ramelli.
In range bound markets traders have to switch up their trading plan. Holding positions for longer periods of time doesn’t exactly work when the market is struggling to find trend. The lack of sustained underlying trend also presents a trader with the problem of a reduced potential reward level.
When markets trade in this type of low volatility and sideways environment traders must be more active in the management of their positions as well. All of these factors can make it difficult for a trader to be consistently successful. We will go over a simple trading plan that can help traders navigate this type of environment. Using standard equity options, options on futures and binary options, we will develop a strategy for trading this type of market environment.
Attempting to call bottoms and tops in markets is something a trader has to do in a sideways market. When trends aren’t established on a medium to longer term time frame the opportunities to buy and hold positions go away.
For example the CME E-Mini S&P 500 futures have been trading inside of a range for the first week of this new quarter and any trader who attempted to hold a position throughout that time is not likely seeing any kind of significant returns. When this is the market in front of us we have to adjust to a more active buy low and sell high plan. With the CME E-Mini S&P 500 futures as an example we will use options on futures and weekly binary options to set up a trade.
First we need to determine how much the market could potentially move by expiration. To make this determination we will look at the price of the futures options at the money straddle. With the futures currently trading around 2045 we can see that the price of the straddle is about 16 points. This tells us that market makers are expecting 16 points worth of movement higher or lower by weekly expiration we can use this information a few different ways.
Set up a weekly binary options trade based on our directional expectation. If a trader has a strong viewpoint on the direction of the market between now and expiration they can trade weekly binary options around the upside or downside targets. For example if a trader thought the market was moving higher they would want to look to buy a binary option with a strike price 16 points higher from current market levels. If they thought the market was going to sell off they would look to sell a binary option with a strike price about 16 points lower from current levels. The trader can then manage their positions throughout the week adding or taking profits as the market tests the established range.
Use the implied move a s a guide for day trading. Once a trader is able to establish upside and downside targets based on the implied move they can use those levels as key support and resistance to trade around. For example with an upside and downside target of 2061 and 2029 respectively a trader can wait for tests of those levels to initiate binary options positions with shorter expirations. They can look to fade movements to these levels or choose to play potential short term breakouts of these levels. Again binary options always offer a trader a defined level of reward and risk.
While some trader prefer range bound markets most tend to fair better in trending markets. Trending markets are simply easier to trade. If a trader is having trouble with a range bound market they may want to consider using binary options and calculated targets to trade in this type of environment. Binaries offer a lot of versatility to a trader and will allow them to express different views across many different time frames on movement in a wide variety of underlying products.
Futures, options and swaps trading involve risk and may not be appropriate for all investors. Past performance is not necessarily indicative of future results.
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