What are Nadex Knock-Outs and how do they work?
Knock-outs, also known as Touch Bracket™ contracts, are financial instruments that are exclusive to Nadex. They are designed to offer our traders opportunities in the markets, with risk management built in. You will have clear profit targets on your trades so you can plan your strategy and pick knock-out contracts that work for you. Get all the excitement of moving markets, with defined outcomes that protect you during trading.
If you’re new to trading, these contracts are structured to provide a simple entry point to the most popular markets, with a built-in exit strategy on each trade. If you’re an experienced futures or forex trader, you have the added benefit of trading markets you are already familiar with, using the same trade analysis techniques.
What is a knock-out?
A knock-out is a financial instrument that has built-in profit targets. The contract has a floor and a ceiling to protect against big losses or lock in profits – as soon as one of these is hit by the indicative price, the knock-out contract expires.
You choose to buy or sell a contract depending on which way you think the market will go. All knock-out trades are limited risk and you will know the maximum possible loss or profit upfront, giving you a built-in plan for every trade right from the start.
How do knock-outs work?
The two main things that set knock-outs apart from other types of financial instruments are the floor and the ceiling, which create a trading opportunity that includes a built-in exit strategy for both profit and loss. Here’s an overview of how they work:
The floor. If buying the contract, this is the level that prevents you incurring major losses. If selling the contract, or going short, this is the level of maximum profit potential.
The ceiling. When buying the contract, this is the take profit that prevents you holding onto a trade for too long and risking the trend reversing. If short, this is your level of maximum risk.
Each week, Nadex will list four unique knock-out contracts for each underlying market: forex major pairs, and the four major US stock indices. If the floor or ceiling is hit at any time during the week, the contract expires and a new one will be created at a different level, providing continuous trading opportunities. The Nadex platform is easy to navigate and will show you the knock-outs that are available at any one time.
To trade knock-outs, you pick contracts according to your market analysis. This means you need to have your own strategies in place first, so you can see which contracts fit in with your trading plan.
Knock-out trading explained
When selecting a contract, you will see two numbers in red and blue. Just like with any market, these are the bid price and the offer price to buy or sell the contract. The two prices will sit between the floor and ceiling. If you buy, you believe the market will move upwards. If you sell, your analysis tells you it will move downwards.
When you open the order ticket, you can choose your price and size, which will immediately show you the maximum risk and maximum profit potential for the trade. Once you have made your decision and placed the trade, there are three possible outcomes.
Let’s imagine you bought a knock-out contract, meaning you think the market will move upwards. These are the possible scenarios:
The knock-out expires at the end of the week, without hitting the floor or ceiling. If it moves upwards, you receive a payout. If it moves downwards, you take a loss on your trade. The amount will depend on how much the market moved – it will be somewhere in between your maximum possible profit and loss.
The indicative price hits the ceiling. The contract expires immediately. You receive the maximum payout*, as outlined before you placed the trade.
The indicative price hits the floor. The contract expires immediately. You take a loss, as outlined before you placed the trade.
* The maximum payout/loss is not inclusive of exchange fees.
Knock-out trading example
Here is a trading example to further illustrate the way knock-out contracts work:
A US 500 contract's current indicative underlying price is 2720.00, with a floor at 2710.00 and ceiling at 2760.00.
Here are the key points you would need to note if you were going to trade this contract:
Current indicative underlying index (buy price): 2720.00
To find out the value of this contract, you subtract the floor from the ceiling, which in this case is 50 points, worth $500.
What happens if you’re going to buy this contract?
As with all Nadex products, your maximum loss cannot exceed what you put into the trade. To find out the maximum risk (and the cost of entering the trade), you need to know the difference between the buy price and the floor. In this instance, it’s 2720.00 - 2710.00 = 10. In the case of the US 500, this equates to $10.00 per point, so your total risk/amount needed to enter the trade is $100.
The maximum potential return is the difference between the buy price (2720.00) and the ceiling (2760.00). 2760.00 – 2720.00 = 40 points, or $400.
At Nadex, we like to make things as simple as possible. All this information will be shown on your order ticket – but it’s useful to understand exactly what it means and how it relates to your trade.
This example excludes exchange fees.
Advantages of knock-outs
These are some of the key advantages of knock-outs:
Trade and go. Once you’ve placed the trade, you can leave your knock-out contract alone. The hard work’s done – now it’s just up to the markets. Of course, if you would like to close out early to lock in profits or limit losses, you always have that option as well.
Risk protection. Whether bullish or bearish, the floor and ceiling structure works to protect you from exorbitant losses, while also providing a natural maximum profit target. This design ensures you quit once your maximum profit objective is achieved, or leave the trade before losses mount up.
A built-in trading plan. You don’t have to decide about sensible take profit and stop loss orders. These are included in the knock-out. You could say it's a contract that provides discipline by design.
If you want a trading option that lasts until expiry regardless of market fluctuations, you may also want to consider call spread contracts.
Are knock-outs regulated in the US?
Nadex Knock-Out contracts, also known as Touch Bracket contracts, are exclusive to our exchange. Nadex is regulated by the Commodity Futures Trading Commission (CFTC), a US government agency that exists to protect market users and the public from fraud, manipulation, abuse, and systemic risk. When you trade knock-outs with Nadex, you are trading on a CFTC Designated Contract Market.
Nadex Knock-Outs: key takeaways
Knock-outs offer a great degree of control while providing short-term opportunities in the markets. They have a lot to offer new traders, as well as those with more experience. As with any financial instruments, you must take responsibility for your trading activity and stick to your own strategies if you want to be a successful trader.
Practice trading knock-outs for free with a Nadex demo account. You will get $10,000 in virtual funds, so you can hone your skills and understand the functionality of knock-outs. After all, the best way to learn is through practice.