Using Binary Options to Trade Direction - Sponsored by Nadex

By Randall Liss AAA

Binary options are an outstanding method of trading market direction, whether it’s going up or down.

As a buyer you can never lose more than you pay for the binary option and as a seller you can never lose more than you pay for the binary option.  For the buyer, the binary trade price is the cost and for the seller, the cost is the difference between the trade price and 100.  At expiration the binary will always settle at either zero or 100 where only one binary participant will receive the payout.  The capped $100 payout makes it easily quantifiable to compare the risk, return and ROI choices at the various binary strikes and durations dependent on your underlying market view.  

Remember the old adage that timing is everything? How many times have you traded where your market call on direction was right only to have the misfortune of being stopped out? With binaries you still have to call the market direction correctly but you have the benefit of a little more wiggle room.

Let’s say it is Tuesday and from your analysis, you’re bullish the EUR/USD but waiting for tomorrow morning’s news release for confirmation. The spot currency is currently trading at 1.3593 and you are anticipating the market to rally around 1.3650 to 1.3660.

Let’s say your time frame for the trade is 1 to 2 days for the anticipation of the trade target to be achieved. Nadex lists its binary contracts for 2 hours, 1 day and 1 week so given our time frame restriction, we will only focus on the daily and weekly binaries. From the daily binary option chain we can compare just a few of the many strikes listed that will expire at 3:00pm EST on Wednesday.

Assumption: Binary Buyer receives settlement payout, cost is offer price and excluded are exchange fees

Daily EUR/USD > 1.3660 - Cost11/ net payout 89/ percent return 809%/ -67 pip disadvantage

Daily EUR/USD > 1.3640 - Cost 19.50/ net payout 80.50/ percent return 413%/ -47 pip disadvantage

Daily EUR/USD > 1.3620 - Cost 31.50/ net payout 68.50/ percent return 217 %/ -27 pip disadvantage

Daily EUR/USD > 1.3600 - Cost 46.50/ net payout 53.50/ percent return 115%/ -7 pip disadvantage

Daily EUR/USD > 1.3580 - Cost 62.50/ net payout 37.50/ percent return 60%/ +13 pip advantage

Daily EUR/USD > 1.3560 - Cost 77.00/ net payout 23.00/ percent return 29.9%/ +33 pip advantage

*One concern could be a missed opportunity if the underlying market makes the expected bullish move after the binary expires.

From the weekly binary option chain we can compare just a few of the strikes listed that will expire at 3:00pm EST on Friday. The weekly binary contracts are listed for trading at 6:00pm ET on Sunday.

Assumption: Binary Buyer receives settlement payout, cost is offer price and excluded are exchange fees

Weekly EUR/USD > 1.3675 - Cost 19/ net payout 81/ percent return 426% / -82 pip disadvantage

Weekly EUR/USD > 1.3625 - Cost 38/ net payout 62/ percent return 163%/ -32 pip disadvantage

Weekly EUR/USD > 1.3575 - Cost 61.50/ net payout 38.50/ percent return 63%/ +18 pip advantage

Weekly EUR/USD > 1.3525 - Cost 81.50/ net payout 18.50/ percent return 22.7%/ +68 pip advantage

*One concern assumes the market makes the expected bullish move by Thursday, within the 2 days however the binary does not expire until Friday.

The full 100 payout is not realized until expiration so your position will gain in value but not the 100 value per contract.  Your choices could be to take a profit now or hold till expiration. If you hold, hopefully the EUR/USD does not sell off and finish below your strike at expiration where your position would be worthless.

Note the 1.3675 strike is higher than your target but if the underlying market moves higher toward the strike, your position would gain in value at some delta of 100. Rule of thumb if underlying is trading around the strike the fair value should be approximately 50.

As you see there are lots of trading choices using binary options with different ROI’s. It really comes down to the individual trader’s risk profile and what they are most comfortable with given their underlying market bias.

Futures, options and swaps trading involves risk and may not be appropriate for all investors.

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