Binary Options Instruments

binary options instrumentsBinary options instruments, or digital options instruments, are greatly misunderstood. The general perception is that binary options are considered to be the (infamous) at-the-moneyOver‘ and ‘Under‘ bets and nothing more.

The Most Simple of Instruments

‘Over’ and ‘Under’s have a dynamic strike price which always matches the underlying asset price. The utter simplicity of this bet boils down to at any moment will the price be higher or lower at some specific time in the future. Yet according to the European Securities and Markets Authority (27 March 2018 – ESMA7198125)binary options are inherently risky and complex products‘. Paragraph (1) of Introduction.

Risky?

Agreed. But not as risky as conventional options, or as ESMA refer to them, vanilla options. And a lot less risky than crossing the road…………

Complex?

I guess that depends on one’s Intelligence Quotient. There is, of course, the possibility that the police force overseeing Europe’s capital markets are a trifle sparing with their honesty? The binary call and binary put are the most simple financial instrument in existence.

N.B. The usage of the term ‘binary options strategies’ is constrained to covering posts with advice and pointers as to how to use these instruments.

Binary Options and Conventional Options

In the mature, conventional traded options market probably in excess of 80% of all trades consist of combinations of calls and puts. Such structures as call spreads, put spreads, straddles, strangles, butterflies, condors, etc. dominate trading. There is every reason to believe that, as the binary option market matures, similar structures will also dominate binary trading.

European

The majority of binary option instruments analysed will consist of structures/combinations of binary options. A binary call spread consists of a long and short binary call with different strikes.

American

Then there are American options which are called American on a technicality. European options can’t be exercised until expiry. American options can be exercised any time. But if an option is a Touch option, the holder would automatically exercise it, assuming it was an American option. Since the touch event is usually good enough for the writer to pay out, the option is automatically assumed exercised. In the event, a standard touch or no-touch options can be considered American options.

Knock-Ins

The kaleidoscope of potential binary options instruments is further expanded with knock-in barrier options. These options have a barrier level which on being hit the whole structure changes into a different binary instrument.

Knock-Outs

Knock-outs are an instrument which have a barrier on which being hit the original strategy goes up in smoke, KO’d.  

Two-Asset

Two-asset binaries and even binary calendar options further add to the catalogue.

A table of binaries can be found lower down this page.

European & American Binary Options

In general there are two distinct forms of binary options and these are:

  1. options that can be exercised prior to expiry, and
  2. options that can only be exercised at expiry.

In the conventional market the first choice are known as ‘American’ options while choice 2 are known as ‘European’ options. The geographical nature of the terms are irrelevant; both 1. & 2. can be traded anywhere in the world.

In the below binary options instrument table American (Touch) Options are in effect barrier options without any other feature such as a knock-in or knock-out appendage.

Binary Options Instruments Table

European Options American (Touch) Options Binary Knock-In Barrier Options Binary Knock-Out Barrier Options Two-Asset Binary Options
binary call options        
binary put options        
tunnel options        
eachway call options        
eachway put options        
eachway tunnel options        
call accumulator        
put accumulator        
tunnel accumulator        

Terminology

Traded options terminology across global options communities differ from one geographical location to another. Trading on some exchanges names a long call with two short calls as a ‘Ladder’. On other exchanges it is a ‘Christmas Tree’. This feature also differs from one asset to another, e.g. time to expiry in the OTC FX market is tenor.

The term ‘tunnel’ will be used in preference to ‘Corridor’ or ‘Rangebet’ which signify the same instrument.

A ‘Knock-Out’ strategy gets knocked out at the ‘barrier’. The ‘strike’ within a ‘Knock-Out’ determines the target level. A ‘Knock-In’ gets converted at the barrier.

Pricing

The biggest binary market is the interbank FX digital options market where prices range between 0 and 1. The retail market is very often priced as a percentage return or from 0 to 100. This site favours prices that are 100x the digital price. For example, an interbank FX  price of 0.4723 will be referred to as the more retail-friendly 47.23.

by: Hamish Raw

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