Trading Binary Options

Strategies and Tactics

Abe Cofnas

• Publisher: Bloomberg Press
• Year: 2016
• Print ISBN: 9781119194170
• eBook ISBN: 9781119194194
• Edition: 2
• Topic: Business
• Subtopic: Finance
• Index: Business

A clear and practical guide to using binary options to speculate, hedge, and trade

Trading Binary Options is a strategic primer on effectively navigating this fast-growing segment. With clear explanations and a practical perspective, this authoritative guide shows you how binaries work, the strategies that bring out their strengths, how to integrate them into your current strategies, and much more. This updated second edition includes new coverage of Cantor-Fitzgerald binaries, New York Stock Exchange binaries, and how to use binaries to hedge trading, along with expert insight on the markets in which binaries are available. Independent traders and investors will find useful guidance on speculating on price movements or hedging their stock portfolios using these simple, less complex options with potentially substantial impact.

Binary options provide either a fixed payout or nothing at all. While it sounds simple enough, using them effectively requires a more nuanced understanding of how, where, and why they work. This book provides the critical knowledge you need to utilize binary options to optimal effect.

• Learn hedging and trading strategies specific to binaries
• Choose the markets with best liquidity and lowest expenses
• Find the right broker for your particular binary options strategy
• Utilize binaries in conjunction with other strategies

Popular in the over-the-counter market, binary options are frequently used to hedge or speculate on commodities, currencies, interest rates, and stock indices. They have become available to retail traders through the Chicago Board Options Exchange and the American Stock Exchange, as well as various online platforms, allowing you the opportunity to add yet another tool to your investing arsenal. Trading Binary Options is the essential resource for traders seeking clear guidance on these appealing options.

CHAPTER 1
Key Features of Binary Option Types

This chapter covers the key features of a binary option contract available globally and in the United States. There are two basic types of binary option trades. The first is the laddered binary options offered at the Nadex Exchange, part of the IG Markets, the Cantor Exchange, the CBOE, the CBOT, and the NYSE binaries, also known as Byrds. The NYSE binaries launched in 2016 and offer binaries on equities. The NYSE entry into binaries allows traders to trade weekly binaries on major equities. The CBOE offers binaries on the VIX and announced binaries on the China A50 index. These are potential game changers for traders who look to use binaries as part of their total trading toolbox.

Nadex and the Cantor Exchange are CFTC approved. Nadex is owned by IG Markets. The Cantor Exchange, owned by Cantor Fitzgerald, is a true exchange and does not make a market in the binaries. In other words, they don’t take the other side of a trade placed by a customer. Instead, liquidity is supplied by independent market makers. The second type of binary option trades is the non-laddered platform, simply offering the opportunity to bet on the whether the price will be higher or lower at expiration. These are not currently allowed in the United States, but are popular around the world.

Later in the chapter, I also discuss the four basic strategies of trading— at-the-money, in-the-money, out-of-the-money, and deep-in/out-the-money— as well as the role of the market maker in the process. The chapter will end with a sample bid/ask scenario.

Defining the Key Features

Let’s start by defining the features that shape most of the laddered binary option selection and trading. These terms will be used time and again throughout this book, so commit these definitions to memory. You’ll come to know them well.

• Expiration date: The time that the option expires.
• Settlement value: The value of the option on expiration. It will be $0 or a $100-fixed payout.
• Underlying market price: This is the actual real-time market price of the underlying contract.
• Contract: This is the basic unit of a trade of one lot. The value of a lot varies among firms. For example, one lot at Cantor is $1. One lot at Nadex is $100. At IG, 0.01 lots is $100.
• Bid: The premium price that a trader receives for opening to sell a contract.
• Buy: This refers to betting the underlying market will go up. A trader opens a trade and pays the ask price associated with a strike price. If the price settles above the strike price, then the trader wins the $100 ask price.
• Sell: This refers to betting the underlying market will go down. A trader puts on an open sell order. The trader pays for an open sell order ($100 – bid). It is $100 – (bid). This is equal to putting on a position, anticipating a decrease in the price of the underlying market. It is also the premium price that a trade pays for closing a position that was bought. The sell is also labeled as the put tab at the Cantor Exchange
• Spread: The difference between the bid and the ask. With any new market, the spread will tend to be narrow as more volume increases.
• Bid size/offer size: This is the number of positions being bought or sold. You will find that the bid and offer size is not useful as an indicator of sentiment.
• Commission fee: The trader may pay a commission fee per transaction. Nadex charges $1 per transaction. Firms offering Nadex binaries may be offering different commissions.
• Start time: At the Nadex, IG markets, and Cantor Exchanges, the start time for a binary trader is fixed at the beginning of an interval. A five-minute trade interval starts, for example, at 05:00 and ends at 05:05. A trader can enter the trade before the expiration, but the time to expiration is not triggered by the entry. In other platforms (discussed later), a rolling start is featured. This means whenever the trader puts on a trade, the trade duration clock starts at that point and ends at the designated duration.
• Settlement value: This is the price the binary firm uses to determine whether the trade is a winner or loser. Notice that there is no agreement between different firms on what is the settlement value. There are different formulas among different firms for determining settlement value. Of particular importance is that settlement value of binary option underlying markets among offshore firms (not regulated in United States, London, or Australia) are often manipulated to reduce winners.
• Expiration duration: Binary expirations refer to the duration of the option. Among global platforms, durations run the board from one-minute to one-week expirations.

Note: The principles of trading binaries apply to all time frames. The short time frames involve more timing skills, and require a focus on momentum indicators and pattern breaks. Longer time frames, such as one day and more, allow fundamentals to influence the price patterns.

Notice that missing here are the option features known as the Greeks—Delta, Theta, Vega, Volga, and so on. They are not really missing. It’s just that they are not necessary to trading weekly or intraday binary options that offer fixed payouts.

Strike Price versus Underlying Market Price

Binary options featuring a laddered approach have several features that need to be thoroughly understood. Some of these features will be familiar to option traders and are common to all options.

The first feature to understand is the strike price. This is the price target a trader anticipates the price will hit at expiration time: at the target, above the target, or below the target. It is important to note that there can be up to 14 strike prices listed by the Nadex Exchange for each underlying contract. When you have a set of strike prices to trade, they are called a ladder.

For example, at Nadex and IG, the weekly binary option ladders are statements in which the trader decides to buy the binary option if he agrees it will be greater than the associated strike price. If the trader believes the settlement will be lower than the associated strike price, the trade that is put on is a sell. See Table 1.1 for examples of binary option ladders. Notice that the strike price closest to the indicative price (which is the market price of the underlying contract) has an ask value near 50. It is always the case that the market price closest to the ask price will be valued near 50.

Another component to understand is the underlying market. The binary option specifically tracks a particular market known as the underlying market. The underlying market for index-related binary strike prices are, except for the currency pairs, the near-term futures contracts. For example, a trader wanting to put on a position on gold would be watching not only the gold...

Table of contents

• Cover
• Series
• Title page
• Copyright
• Preface
• Acknowledgments
• About the Author
• INTRODUCTION: What Are Binary Options and Why Are They Important?
• CHAPTER 1 Key Features of Binary Option Types
• CHAPTER 2 Identifying Profit Return Potential in Binary Option Trading
• CHAPTER 3 Sentiment Analysis: New Predictive Tools
• CHAPTER 4 Tracking Fundamental Forces That Impact Markets: A Primer for Binary Traders
• CHAPTER 5 Basic Technical Analysis
• CHAPTER 6 Advanced Technical Analysis: Volatility Tools
• CHAPTER 7 Binary Option Trading Strategies
• CHAPTER 8 Analyzing NFP Data for Binary Trading
• CHAPTER 9 Risk Management in Theory and Practice
• CHAPTER 10 Metrics for Improving Binary Trading Performance
• CHAPTER 11 Performance Tools and Training for Improving Binary Option Trading
• Afterword
• Appendix A: Test Your Knowledge
• Appendix B: More Training Tools and Tests
• Index
• EULA