by Nick. Sudbury
Binaries have much to offer the short-term trader. Uniquely they allow people to stake a fixed amount on a specific outcome while also providing the flexibility to close the position early. The advantage of this type of win-lose proposition - like backing the Dow to close the day up, or sterling/dollar to end the hour lower - is that it virtually guarantees fast-moving prices, even when the underlying is quiet. Recent innovations have also opened up a number of more esoteric opportunities. Nick .Sudbury explains...
With a binary bet the maximum profit and loss are both fixed from the outset. This is feasible because they are defined so as to have only two possible outcomes, success or failure, which settle at 100 and 0 respectively. When 'in running' their value is governed by three main factors: the price of the underlying compared with the target price, the volatility, and the remaining time to expiry.
An early fall of 15 points on the FTSE may see the price for the index finishing the day higher moving to 30-34. Buying at £2 a point would therefore risk a maximum loss of £68. If the index subsequently started to rise then so too would the price, and the position would move into profit. Should the FTSE still be trading higher as it approached the official close at 4.30pm, the quote would be getting near to the settlement value of 100 points.
A successful bet held to the close would produce the maximum profit, which in this example is 66 points, or £132. Had the index finished the day lower, the binary would have settled at 0. The other option would have been to close the position in running, using the live price at the time, to take an early profit or restrict the loss.
Simon Denham, a director at Capital Spreads, says that binaries can be fun punts with fast-moving profits and losses. 'They are especially useful when the markets are not doing very much. If the binary is oscillating around the yes/no point they can catch a move quite nicely.'
Binaries are available on a wide range of markets from global indices, to commodities, FX and individual shares. There are hourly, daily and weekly bets and a whole choice of different boundary conditions including one-touch, no-touch, tunnels, ranges and the simple up/down.
The whole concept of binaries was pioneered by IG Index, which still offers the widest choice of bets on the market. Tim Hughes, head of sales at IG Index (we review IG Index here), says that the recent increase in volatility has lead to a massive surge in its binary trading volumes. 'The most popular binaries tend to be those based on the major indices such as the FTSE and the Dow. When strong, early price moves dictate the direction for the day we tend to see the interest shift to the intraday bets such as the hourlies. The tunnels have also proved popular. These allow people to bet whether an index will move by more or less than a certain amount, and gives them the chance to take a view on the day's volatility.'
One of the beauties of binaries is that they can magnify relatively small changes in the underlying into significant price movements. At 2pm on 10 September, for example, the FTSE was up 20 and the bet on the index to finish the day down was trading at around 20 points. After a weak opening on Wall Street the quote moved sharply higher and went on to settle at 100, with the index closing down 40. The advantage of trading a reversal such as this is that it only risked a maximum loss of 20 points but stood to gain a possible 80.
Late reversals have been a feature of the Dow in recent weeks and the binary offers a good way to play them. It is generally a case of looking at the daily Wall Street up/down at around 7pm and deciding whether the trade is on. This type of approach would have potentially produced big profits on 20, 21, 27 and 30 August and 10 September.
'In recent weeks we have seen a number of occasions when big moves on the Dow have unwound late in the day. The binaries come into their own in these sorts of scenarios as they offer exceptional potential returns with very limited downside,' says Hughes.
One way to use this type of bet is ahead of a major announcement. 'If the FTSE was down 30 shortly before the release of the US nonfarm payrolls figure, then betting on the index to finish the day up would be quite a cheap punt. I've done it myself on a couple of occasions to act as a partial hedge against a longer-term short.'
This article originally appeared on MoneyAm Shares Magazine
