Sometimes known as a collar option, fence trading is often used when markets are unpredictable and prices are moving in both directions. There may be no established trend and prices may change quickly. This type of strategy can help you overcome these challenges, enabling you to at best double your returns and at worst limit your losses.
When fence trading binary options, you create a range, or two fences, to make your trades. Although this may mean you’re successful less frequently, you’ll have twice the return when you are and overall are likely to be more profitable.
Opposite Direction Moves
Typically, you’ll undertake fence trading if you believe a price will move one way in the short term but in the opposite direction over a longer period. You may also change your mind about how an asset will perform after you’ve made a trade.
You may place a call option because you believe the price will be higher at the expiry time. Although the price may move in the predicted direction, you then think that the price will be lower later and so place a put option in the expectation that the price will be down at a later time.
Each contract establishes a fence and if the price falls between them for both, you’ll finish up in the money twice. The worst case is that both fall outside the two fences and you lose your stake for each one.
When you’re making this type of trade, you change from a bullish to bearish view or vice versa. You therefore need to time the second trade for when the price has reached its highest or lowest level and is about to change direction. Failing to do this may mean the price carries on in the same direction and the second trade ends out of the money.
Example of a Fence Strategy Trade
Gold is currently priced at $1500 an ounce but you’re expecting news in the next hour that you think will cause the price to rise. As a result, you place a call option for $1000 that expires in two hours.
The price does start to rise as expected but you then hear that the news won’t be as good as had been hoped and that the price is likely to fall back as a result. You therefore purchase a put option for $1000 when the price is $1550, which expires one hour after the first trade.
If the price ends between the two levels for both trades and the payout is 80%, you’ll receive back in total $3600, giving a profit of $1600. A final price of $1575 for both means you win the call and lose the put, getting $1800 back against your $2000 stake. Conversely, a level of $1475 for both gives the same payout with a loss on the call and a win on the put.
The worst possible outcome is that the price moves in the wrong direction on each trade, ending at $1475 at the first fence and then moving up to $1575 for the second one. In this case, you’re out of the money on both trades and stand to lose $2000.