Double No Touch Option Strategy

The double no touch option strategy is used when a binary options trader wants to short volatility in a currency pair. In theory, asset price movements are normally distributed, the standard deviation of the distribution can be measured using past price return data.

The chart depicted below is that of the normal distribution, also referred to as the bell-curve or Gaussian distribution. The standard distribution is a statistic that measures the amount of randomness around the mean (the highest point on the bell curve). Many traders use it as an indicator of how risky an asset is. Historical volatility is measured from past data. In vanilla options trading, the market does not price options based on historical volatility. However, they use the markets implied volatility (driven by supply and demand).

(Source: http://en.wikipedia.org/wiki/Standard_deviation)

For example, let’s assume one of the following is happening in the market place:

• Political Uncertainty (like the US Government Shutdown, Geopolitical Risks from the Middle East).
• Economic Reports due to be release.
• Central Bank Meetings.
• FOMC Statements.

Remember, historical volatility is not forward looking, it is based on past data. Implied volatility is forward looking. A savvy trader will know that during one of these events they can expect larger than normal moves in a currency pair. They would expect to see an increase in implied volatility, since no one is sure of how the outcome will affect the currency pair. With that said, options will be priced higher due to this uncertainty.

The double no touch option strategy looks to take advantage of a decrease in (implied) volatility. The strategy makes sense to put on when volatility is elevated. After all, once the announcement is made, the uncertainty disappears and the new information is absorbed into the market.

How the strategy works

This is a neutral trade, meaning that you don’t have a directional bias, you are not bullish nor bearish. You are betting that the currency pair does not reach a certain level on the upside or downside.

Typically, the trader will pay their broker a specified premium and select the two options (price levels they feel the currency pair will not hit). If the currency pair stays in between the two levels the trader selected (and doesn’t touch them during the contract life), they will be winners (payout is fixed). In vanilla options trading, this strategy is often referred to as a short strangle and has unlimited risk. When implementing this strategy using binary options, your risk is limited to the premium paid.

During periods of low volatility, the payout will be small, since there is a higher probability that the currency pair will continue to experience small price movements. However, during periods of uncertainty, the payout will be greater since there is a better chance that there will be wilder price moves.

Highly technical traders who have a good grasp of price levels (support/resistance) can also implement this strategy, you don’t have to be an expert in volatility (although it does help to have a strong understanding of the concept). For example, the strategy might also make sense to implement during sideways market conditions. It’s unfavorable during trending market conditions.

For example, let’s assume that the EUR/USD is trading at 1.35, and we think it will stay between 1.31 and 1.38 over the next week or so. We’d select the 1.31 and 1.38 strikes (or barriers). Now, if it doesn’t hit our levels throughout the contract life, the trade will be a winner.

Again, this strategy makes most sense during periods of uncertainty because of the higher payout. Also, technical traders can implement it during sideways markets. All in all, this is a viable trading strategy that should be incorporated under the right market conditions.