How to Trade with Defined Risk on Nadex

The Power of Nadex

            What is Nadex?  The North American Derivatives Exchange is a Chicago-based exchange that allows traders to trade currencies, commodities, indices, or even news events at a quick pace.  These derivatives can be traded on a 2 hour, daily, and weekly basis.  The most intriguing part of Nadex may be the risk to reward ratios available, fees as low as $0.90 per contract, or knowing your maximum profit and loss for every trade you make.  Some contrarians might initially view this with some skepticism and label it as gambling. However unlike the casino, with Nadex the ability of spotting market trends and limiting trade risk, as well as the ability to trade out of contracts before expiration render Nadex trading in a class by itself.

In Nadex, there are two types of option trades: binaries and bull spreads.  Binaries are basically limited-risk derivatives based on yes/no or true/false propositions.  These binaries are measured and bought on a price scale from “0” to “100” (the closer to “0” the more likely that binary will expire false and the closer to “100” the more likely that binary will expire true).  Another way to look at it is the higher the binary is above the current market price, the closer to “$0” the binary will be priced and the lower the binary is below the current market price, the closer to “$100” the binary will be priced.  If the binary and market price are close to each other, then the binary will be priced close to “$50” per contract (50/50 probability).

For example, if gold is trading at $1605 an ounce at 8:30 a.m., and you think it will be trading above $1610 an ounce by 10:00 a.m., then you would buy the “>$1610” binary.  If you think otherwise, then sell the binary.  Since your target price is above the current market price in this trade, you may only pay $20 per contract to make $80 if you’re right or lose that $20 if you’re wrong.  Selling this binary will result in a $20 gain if you’re right and an $80 loss if you’re wrong.

Another way to trade on Nadex is through bull spreads.  Bull spreads are derivatives with built-in ceiling and floor levels which show the highest and lowest points the contract can settle.  Their ranges vary depending on the underlying market (indices, commodities, and currencies) along with how much time there is until expiration.  For example, since the Dow Jones Industrial Average index is much larger than the S&P 500 index, the Dow’s bull spread range will be larger than the S&P’s.  Similarly, a contract that expires at the end of the week’s bull spread range will be wider than those that expire daily or every 2 hours.  The range of the bull spread represents the maximum profit and loss (the ceiling and floor).  When buying a bull spread, every dollar above your purchase price up to the spread’s ceiling is your potential profit and every dollar below your purchase price down to the spread’s floor is your potential loss.  When selling a bull spread, every dollar below your selling price down to the spread’s floor is your potential profit, while every dollar above your selling price up to the spread’s ceiling is your potential loss.

Suppose the S&P is trading at 1307 at noon and you believe that is as low as it’s going to go for the next hour.  You could buy the “S&P 500 1305-1315” bull spread that expires at 1 p.m. for about $20 (the closer to expiration the lower the premium).  Your maximum gain would be $80 (if S&P closes above 1315 at 1 p.m.) and your maximum loss would be that $20 initial purchase (if the S&P closes below 1305 at 1 p.m.).  If the S&P closed at 1313 at 1 p.m., then your profit would be $60, but if the S&P closed at 1306 at 1 p.m., then your loss would only be $10.  Contrarily, if you thought the S&P was at its high for the next hour, you might sell the “S&P 500 1300-1310” bull spread that would also expire at 1 p.m. for about $30.  Your maximum gain would be $70 (if S&P closes below 1300 at 1 p.m.), while maximum loss is $30 (if S&P closes above 1310 at 1 p.m.).

What’s unique about Nadex is the ability to always know your maximum gains and losses which provides better risk management for any trader.  Whether you prefer to risk $10 to potentially make $90 or would rather risk $80 to potentially make $20, Nadex’s limited-risk style allows traders to trade with confidence.   You can view the video below to learn more about Nadex Trading Strategies: