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When playing the stock market it is nice to know exactly what you stand to win or lose. No one wants to get taken to the cleaners, but what certainties are there? Nick Sudbury gets to the point

Binaries have much to offer – they allow people to stake a fixed amount on a specific outcome while also providing the flexibility to close the position early. The advantage of this type of win-lose proposition – like backing the Dow to close the day down, or sterling/dollar to end the hour up – is that it virtually guarantees fast-moving prices, even when the underlying market is quiet. Recently of course, the market has been anything but quiet, but here binaries score again, as any potential losses are limited. This is because, with a binary bet, the maximum profit and loss are both fixed from the outset. This is feasible because they are defined so as to have only two possible outcomes, success or failure, which settle at 100 and 0 respectively. When ‘in running’ their value is governed by three main factors: the price of the underlying compared with the target price, the volatility, and the remaining time to expiry.

An early fall of 15 points on the FTSE may see the price for the index finishing the day higher moving to 30-34. Buying at £2 a point would therefore risk a maximum loss of £68. If the index subsequently started to rise then so too would the price, and the position would move into profit. Should the FTSE still be trading higher as it approached the official close at 4.30pm, the quote would be getting near to the settlement value of 100 points.

A successful bet held to the close would produce the maximum profit, which in this example is 66 points, or £132. Had the index finished the day lower, the binary would have settled at 0. The other option would have been to close the position in running, using the live price at the time, to take an early profit or restrict the loss.

Home in on the range

Binaries are available on a wide range of markets from global indices, to commodities, forex and individual shares.

The concept of binaries was pioneered by Binarybet.com, which still offers the widest choice of bets on the market. Tim Hughes, head of sales trading at sister company IG Index, says that the recent increase in volatility has lead to a massive surge in its binary trading volumes. ‘The most popular binaries tend to be those based on the major indices such as the FTSE and the Dow. When strong, early price moves dictate the direction for the day we tend to see the interest shift to the intraday bets such as the hourlies. The tunnels have also proved popular. These allow people to bet whether an index will move by more or less than a certain amount, and gives them the chance to take a view on the day’s volatility.’

‘The other factor that’s attractive about binaries in the current volatility is the fact that the losses are always fixed. There’s

the potential to make huge gains, or sell positions back, but as you’ll know the maximum loss you’re not going to lose your shirt.’

Best of both worlds

One of the beauties of binaries is that they can magnify relatively small changes into significant price movements. At 2pm on 10 September last year, for example, the FTSE was up 20 and the bet on the index to finish the day down was trading at around 20 points. After a weak opening on Wall Street the quote moved sharply higher and went on to settle at 100, with the index closing down 40. The advantage of trading a reversal such as this is that it only risked a maximum loss of 20 points but stood to gain a possible 80. Late reversals are a common feature of major indices such as the FTSE and Dow, and binaries offer a good way to play them.

More recently, of course, volatility has reigned supreme and large, three-digit moves have been commonplace on the major indices. On 23 January, for example, the FTSE finished down 130.8 points after trading over a 326-point range during the day. During this session, many traders would have turned to the tunnels and hourly bets. There would also have been significant opportunities to trade down bets whenever the FTSE moved up strongly.

Bespoke binaries

Another advantage of binaries is that they are available in many permutations, and there are many innovative providers in the market that offer clients a high level of control over their binary trades. It is possible, for example, for traders to select a specific strike price and time expiry. There are hourly, daily and weekly bets and a whole choice of different boundary conditions available; including one-touch, no-touch, tunnels, ranges and the the simple up/down bets outlined in the examples above.

This means that traders can use binaries to take positions on a range of

markets and adapt them in the way that suits them

best to optimise their trades – and all in

the knowledge that any down side is limited. In the current market, a little control could go a long way.