A  A  A     

Trading Binary Options

Binaries   Binaries                                                            

"CBOE Binary Options are a pure and simple way to trade based on your opinion of where a market is headed over a certain period of time."

Bullish Strategy

Example: You think the S&P 500 Index will be at or above 1275 by the third week in August.

The market has just had a significant sell off and you think that within the next few weeks it will bounce back up. The S&P 500 Index is currently at 1260.

You buy one August 1275 Binary (BSZ) contract for .38 (cost of $38), speculating that the S&P 500 Index will be at or above 1275 by August 15th. If you are correct, you will receive $100, realizing a $62 profit ($62 = $100 less $38 paid up front).

However, a surprise move by the Fed spurs the market to rally over the next two days and the S&P 500 Index moves higher. The August 1275 Binary contracts increase in value to .73 ($73) and you decide to sell your contract and pocket a .35 ($35) profit ($35 = $73 less $38 paid up front).

Alternatively, you could hold on to your contract until the expiration date (usually the third Friday of the month for BSZ) and receive $100 cash payout if the S&P 500 Index settlement price is at or above 1275. However, you will receive nothing at all (and have a net loss of $38) if the S&P 500 Index settles at a value less than 1275.

Strategy idea: Binary contracts can be bought or sold to open. If you have a portfolio of stocks, you might consider selling BSZ options and collecting the premium to enhance returns. This is a possible alternative to a traditional BuyWrite strategy of selling SPX options, where the upside profit potential is capped at the strike price. Because CBOE Binary contracts have a maximum payout of $100, your maximum loss on the short BSZ Binary is limited to $100.

Bearish Strategy

Example: You think the CBOE Volatility Index (VIX) will be at or below 30 by the third week in September.

Because of recent turmoil in the markets, the CBOE Volatility Index, VIX, is at a relatively high level of 29. You decide that the market volatility is over for the time being and that VIX will go down and stay below 30 for some time.

You decide to sell the September 30 Binary contract which is currently trading at a price of .52 ($52). You collect $52 into your trading account, but if you are wrong at expiration (the third Thursday in September) and the VIX is at or above 30, you will owe a total of $100. You have collected $52 upfront, but you need to keep an additional $48 in your account until the contract expires to cover the possible $100 payout at expiration (or until you trade out of the position by buying a September 30 Binary).

It turns out that more bad news develops that sends the markets lower and the CBOE Volatility Index higher, with VIX trading over 30 on several days. However, CBOE Binary contracts trigger a payout (or not) only at expiration and in this case, by the time the expiration date comes, the markets have calmed and VIX is trading as you predicted, at 28. Because the VIX level is below 30 at expiration, no payout is triggered and you keep the $52 that you collected when you sold the contract.

Strategy idea: VIX options are often used by money managers as a portfolio diversifier due to its tendency to go up when the market is going down. Slightly 'out of the money' BVZ options (e.g. if the VIX is at 27, buy the BVZ 30 call )might be less expensive than traditional VIX options, but are still likely to increase in value if the market has a significant down move and the VIX increases. In that case, a profit on your BVZ Binary can cushion a loss in your portfolio.

"Range Trade" - S&P 500 Binary Call Spreads

An investor believes that the market is going to trade in a narrow range during the summer. One way to trade that opinion is to buy S&P 500 Binary Call Option spreads; that is, simultaneously buy a Binary Call Option and sell a second Binary Call with a higher strike price.

Suppose that the S&P 500 Index on July 1, 2008 is 1,350; the price of an in-the-money (i.e., 1325 strike price) S&P 500 Binary Call Option expiring on August 15, 2008 is 0.58 (or $58 per contract), and the price of an August 1375 Binary Call is 0.38 ($38 per contract). Now suppose that the investor buys ten spreads, paying a total of $200 premium ({0.58 - 0.38} x 10 contracts x $100 multiplier), excluding transaction fees and other expenses.

At expiration, S&P 500 Binary Options have only two possible payouts: 1) $100 if the Opening Settlement Value for the S&P 500 (Ticker - "SET") is equal to or greater than the Binary Option strike price; or 2) $0 if SET is less than the strike price.

For the long Binary Call Option, the investor would receive $100 per contract if the SET value were 1,325 or higher at expiration. For the short Binary Call Option, the investor would have to pay $100 per contract if the SET value were 1,375 or higher at expiration.

The table below illustrates the spread payouts and P&L of 3 possible outcomes: 1) SET is below 1,325; 2) SET is at or above 1,325, but below 1,375; and 3) SET is at or above 1,375.

First, let's look at the two scenarios in which the S&P 500 settles outside of the investor's expected trading range. If SET is less than 1,325 on August 15, then both spread legs settle out-of-the-money and have a value of $0 at expiration. The investor takes a $580 loss on the long Binary Call position, which is partially offset by a gain of $380 on the short Binary position. The net loss on the spread position is $200.

If SET is at or above 1,375 at expiration, then both legs settle in-the-money and have a value of $100 per contract. The long position would have a gain of $420, but the loss on the short position would be $620, a net loss of $200.

Scenario Long Value Short Value Spread Value Long P&L Short P&L Spread P&L
SET below 1,325 $0 $0 $0 ($580) $380 ($200)
SET at or above 1,325, but below 1,375 $1,000 $0 $1,000 $420 $380 $800
SET at or above $1,375 $1,000 ($1,000) $0 $420 ($620) ($200)

However, if SET is between 1325 and 1375, the Binary Calls would have payouts of $100 and $0, respectively. The investor would realize a $420 gain from the long Binary Option position, plus a $380 gain from the short Binary Option position. The net P&L would be $800.

The chart above graphically illustrates the P&L profile of a Binary Option Range Trade and the distinctive "all-or-nothing" payout that characterizes binary-style contracts. An investor should expect that the cost of a Binary Call spread covering a broad range of index prices will generally be higher than other Binary Call spreads defined by narrower ranges. Intuitively, this makes sense because the likelihood of settling within a specified range tends to increase as the range widens.

Copies of the ODD are available from your broker, by calling 1-888-OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606. The information on this website is provided solely for general education and information purposes and therefore should not be considered complete, precise, or current. Many of the matters discussed are subject to detailed rules, regulations, and statutory provisions which should be referred to for additional detail and are subject to changes that may not be reflected in the website information. No statement within the website should be construed as a recommendation to buy or sell a security or to provide investment advice. The inclusion of non-CBOE advertisements on the website should not be construed as an endorsement or an indication of the value of any product, service, or website. The Terms and Conditions govern use of this website and use of this website will be deemed acceptance of those Terms and Conditions.

CBOE Volatility Index (VIX)