Exotic options can be really appealing at first glance, but most people actually lose money on them. This fact shouldn’t be a surprise; most people lose money on regular call and put options, too. However, just because most people lose money here doesn’t mean that you need to fall among this category. Exotic options are beatable, you just need to pick and choose your battles. Here, we will give you a brief guide on how you can get started in doing just that. Hopefully this will help you to get to the point where you are not losing money with this type of trading.
There are a few different types of exotic options, but for the purpose of this article, we will talk about just the one touch trade and the boundary trade. One touch options involve an asset reaching a previously given price at any time before expiry. If this occurs, then the trade is a profitable one. If not, then the trade is a losing one. These work best in volatile situations.
A boundary option gives you a range of prices, and you are tasked with figuring out whether the option will finish inside or outside of the given range, or boundary. These are sometimes called in or out trades, or inside or outside trades.
Both boundary and one touch options come in high yield varieties, which are discussed below.
These are certainly interesting types of options, but how useful are they? In practice, they are far less beneficial to you then a typical call or put option. However, you will find that knowing how to use them can be handy, especially when a high yield opportunity comes up.
High Yield Options
High yield options have a large return—typically more than 100 percent. Along with that high rate of return, you also have a much tougher time of being correct in your prediction. But that’s okay. You only need to be right with these once in a while for these to be effective. That’s the first step to success here: find out how often you need to be right to turn a profit.
This might seem complex, but it’s fairly easy. First, start with your stated rate of return. Let’s say you have a return of 250 percent. For every $100 you risk, a correct trade will return $350. That is, the initial $100 plus $250 in profit. Next, take a hypothetical 100 trades. If you are correct on 29 of those, that means you have profited $7,250 and lost $7,100. That’s a profit of $150. So 29 percent is the bare minimum you need to achieve to be profitable with these long term. However, that’s a lot of risk for a tiny profit. Ideally, you would like to have your confidence rating much higher than 29 percent if you are going to take out a high yield trade.
This is a number that’s easy to adjust with different yields. All you need to do is determine the breakeven number, then determine your likelihood of success. If your likelihood of success is below the breakeven point or too close for comfort, you are better off avoiding a trade. The more experience you gain trading, the better of a judge you will be here.
Ultimately, what you will find is that most exotic trades should be avoided. However, they can prove to be very fruitful once in a while, so they are worth knowing how to use them and looking at them on your broker’s platform at least a few times per week. When they are profitable, they will be quite beneficial to you.