What Is a Double No-Touch Option?
A double no-touch option is an exotic type of option which gives the holder a specified payout if the underlying asset price remains within a specified range until expiration. The buyer negotiates the price range, called the barrier levels, with the seller. The seller is often a brokerage firm.
The maximum possible loss is the cost of setting up the option. The maximum profit is the negotiated payout amount minus the cost of purchasing the option. Typically, the buyer specifies how much they would like to risk, and the broker provides a percentage payout based on this amount (and other factors) which keeps the structure quite simple.
Double no-touch and the converse, double one-touch, options are both in the binary options category. Binary options have a "yes or no" logic basis. Either they payout the full amount or they pay zero (buyer loses their investment).
- A double no-touch option falls under the binary options trading category, meaning the option has a fixed payout and fixed risk.
- The buyer of the option receives a fixed payout if the price stays within specified price boundaries until expiration.
- If the price touches or exceeds the price boundaries at any time, the trader loses what they paid for the option.
- Since brokers set the payouts and costs of these options, the risk/reward typically favors the broker.
Understanding the Double No-Touch Option
Because they have a "yes or no," or binary payout, double no-touch options are in the binary options category. They are bets that the underlying asset will not move beyond the barrier levels by a certain date. Because of this structure, they bring an element of gambling into the equation. Indeed, these types of options and their sellers are prone to fraud, which is why many jurisdictions ban these products. The payouts tend to favor the sellers/brokers, not unlike the way gambling games in casinos favor the "house."
The double no-touch option could be useful if an investor believes the price of an underlying asset will remain range-bound over a specified period. Double no-touch options tend to be offered to binary options traders mainly in the forex (FX) markets.
For example, if the current EUR/USD rate is 1.15, and the trader believes this rate will stay static over the next 15 days, the trader could use a double no-touch option with barriers at 1.10 and 1.20. The investor can profit if the rate does not move beyond either of the two barriers.
The trader could also accomplish the same goal with traditional options by using a short strangle strategy or a short straddle strategy. The advantages of regular options include liquidity, transparency, and minimal counterparty risk.
With most double-no touch options there isn't actually a cost upfront, rather the trader just decides how much money they want to invest in the option based on the payout the broker is providing. The broker determines the payout based on several factors. They will offer lower payouts if the barrier levels are wider. This is because there is a greater likelihood the levels won't be touched, which means the buyer receives the payout.
A shorter time frame until expiration will also lower the payout since in a short amount of time the price isn't likely to move much. If the price doesn't move much and thus doesn't reach the barriers, the buyer receives a payout. The more likely it is that the price will stay between the barriers, the lower the payout the buyer will receive from the broker. This is because the broker wants to protect themselves and will, therefore, build their protection into the payouts that they offer.
A double no-touch option is the inverse of a double one-touch option. The holder of the one-touch option receives the payout if the price of the underlying asset touches or moves through either of the barrier levels.
Double No-Touch Options Versus Regular Options
As previously mentioned, double no-touch options are not the same as regular or vanilla options. No-touch and all other binary options are primarily over-the-counter instruments. The buyer and seller negotiate the terms, which includes the payoff amount, barrier levels, and expiration date. In practice, no negotiation goes on. The broker provides the terms and the buyer either accepts them or doesn't trade.
Most binary options result in only two outcomes. The buyer loses what they paid for the option, or they receive a payout. In some cases, the broker may allow the buyer to exit the trade prior to expiry, usually resulting in a partial loss or profit.
Regular options trade on formal exchanges and give the holder the right, but not the obligation, to buy or sell the underlying asset at a specified price by or on a particular date. They also have standardized strike prices, expirations, and contract sizes. This standardization gives them the advantage of liquidity in a secondary market, and more assurances for both the buyer and seller that the trade and exercising, if it occurs, will take place promptly and smoothly.
Regular options tend to be fairly priced based on market conditions, since the price is set by both buyers and sellers. With a double no-touch binary option, everything is set by the broker selling the option, which typically skews the risk/reward in the broker's favor.
Example of a Double No-Touch Option Trade
Assume a trader is watching the USD/JPY. The current rate is 108.55. The trader believes that the price is likely to stay between 109 and 108 for the next 24 hours.
They purchase a double no-touch option with these barrier levels, expiring in one day, and invest $100. The broker is offering a payout of 50%. That means that if the price stays between 108.999 and 108.001 the buyer will receive $50 (and their $100 back), since the price didn't touch or exceed the barriers.
If the price touches 109 or above, or 108 or below, the trader loses their $100.
The payout or loss will automatically occur within the trader's account when the option expires.
A 50% payout may sound very good for a day's work, yet the trader is risking 100% of their invested capital to only make 50%. Most traders seek to make more on winners than they lose on losers, and this payout is actually the opposite of that goal. The trader will need to win twice for every one loss just to breakeven.
Also, if the payout is higher, such as 80%, that means it is highly unlikely that the price will stay within the barriers of that contract. The payout is higher, but the chance of receiving the payout will be very low.