Limit Risk with Binary Options

08/22/2011 3:30 pm EST

Focus: OPTIONS

Dan Cook

Director of Business Development, Nadex

Dan Cook explains that using binary options provides the trader a valuable benefit of clearly defined maximum risk on every trade.

Dan Cook is my guest, and Dan, all investors and traders alike are worried about risk. Do we have any products now that can help us limit risk?

With Nadex, all of the products we offer, whether it be full spreads or binary option contracts, are limited risk.  What this means, and it is so important—we’ve seen several market events just over the last year; they’re not uncommon.

The flash crash was a prime example, and we’ll talk about that in a minute, but the yen, in the middle of March, 400 points in a matter of minutes. It’s hard to really define that risk. 

With Nadex, when you place a trade on any type of contract, you know ahead of time what your maximum losses could be, and that’s very important. 

In any other market, pretty good leverage markets, we never really know. If there is a giant market event or a gap, it can really crush the retail trader, so it’s hard to gauge that. 

If I trade on Nadex, if I put $40 into a contract, that’s my maximum loss. That happens to be the collateral that I put up, and so I don’t have to face margin calls.

So we don’t have to worry about the leverage and all that exposure?

Correct, I know ahead of time. That’s one thing that’s tricky about leverage. If we take the flash crash, for example, nobody knew it was going to come. Everybody was astounded. We had billions of dollars just evaporate in seconds. 

Really, it didn’t matter if you had a stop in the market, your stop was not getting filled because the market was gapping over. Now, if you’re just trading cash and no leverage, that’s bad enough, but if you’ve got it leveraged maybe 50/1, which is not uncommon in the currency market, you don’t know what your losses could really be.

With Nadex, because they’re an options-type product, I know that risk up front. Even if the underlying market goes crazy and I was wrong, I don’t face a margin call. 

More importantly, even more than a margin call, while those are painful, I don’t have to worry about the aspect, which typically in leverage can happen, where maybe I have $1000 in an account, a big market event happens, and all of a sudden I get a call from my broker that I owe them $2000 more. 

It’s pretty difficult to explain to the other family members when they were looking to go on the trip that we just can’t do it. So by knowing that risk up front, and Amos Hostetter said it, take care of your losses and the profits take care of themselves. 

Everything as a trader we need to really worry about is risk and controlling that. The only way we can do that is through an options-type product, which is what Nadex offers.

More: Visit the Options Center

You talked about the flash crash, and we don’t know what caused that, and many people are thinking we might see another one. Do you buy that?

You know, without knowing what caused it, I don’t see any reason why not. We have circuit breakers, which kind of do that, but even so, we can still see big gaps even with the circuit breakers. We’ve got a lot of high-frequency trading; we’ve got so many thousands of trades going through in a second with computers just pumping volume, particularly in the equities markets, and so without knowing a cause, it’s hard to say it can’t ever happen again.

All the more reason to have some sort of protection in place. 

All the more reason, certainly. If you can put it up, it should be risk capital. You may lose it, but you knew ahead of time what that was, and there’s no big surprises at that point.

And you’re prepared to take the loss; you can live with that.

You can plan for it, exactly.

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