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Binary Breakdown Trading Choices

TradingPub Admin | May 22, 2014

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So where does it start? If you’re already trading futures or spot fx, then you have a trading opinion, or at least market bias. That’s all you need to trade binaries, which give you another trading choice to add to your arsenal.

The Binary instrument offers a defined risk and return at the contract expiration, which can be assessed before putting on the trade, if it fits your market bias.

The interesting part about the binaries is upon expiration of the contract, the payout value is not variable, but an all or none feature, which has a notional value of $100 per contract.

Your trading style…. Be it short term, swing trader, fundamentalist or technician doesn’t matter. If you want to use Nadex binaries, your market bias of the underlying has to have a time frame within a week or less to benefit from the fixed term odds of the instrument when initiating the trade. With binaries, it either makes sense given your underlying market view or not from the defined risk/reward ratios of each binary strike price.

So let’s go through some of the binary choices to help you understand the process of what should be considered when choosing the vast array of Nadex binaries.

Assumption: you’re looking for the EUR/USD to have a big move by the end of the week.

Currently the EUR/USD is trading at 1.3791.

The longest duration available on Nadex is a week, so if you’re looking for a longer time frame than what Nadex offers, this might not be for you.  Let’s say you are looking for a move by the end of the week….you’re looking for a trade target of 1.3910 for the EUR/USD by week end.

Below are the weekly binary strike prices and remember, the underlying market needs to close above the strike at expiration for the binary buyer to receive the $100 expiration value.

Assume we are lifting offer prices to compare a few of the binary strikes ROI’s (not inclusive of exchange fees)

05.22.14 Nadex 1

Buy EUR/USD >1.3925 (3PM) … cost $7/contract…net profit at expiration $93/contract…ROI 1328.6% if EUR/USD finishes over 1.3925

* Your first concern is that the strike price is above your trading target, so the underlying market has to rally over 134 pips and finish above the strike price, but if the EUR/USD does end up rallying, as you expect, your binary will increase in delta value. The binary price will increase in value as the underlying EUR/USD market gets closer to the strike price, where you will always have the option to close the trade prior to expiration, to realize a quick profit.

*The binary pricing is also a probability of event outcome, which is 7% at the time of trade.  Low probability=low cost=higher ROI.

Buy EUR/USD >1.3875 (3PM) … cost $17/contract…net profit at expiration $83/contract…ROI 488.2% if EUR/USD finishes over 1.3875

* Your trading target is above your strike price this time, so the underlying market only has to rally over 84 pips and finish above the strike price.  Your trade target is higher than the strike price enough so, that if it comes down to the wire at expiration, you mostly likely won’t have to subject yourself to the volatile binary pricing, due to the gamma play of the expiring at the money strike prices.

* Note that with this strike price as a binary buyer, the market is placing an improved probability from a lower strike price of the event outcome, which is a 17% chance at the time of trade

Buy EUR/USD >1.3775 (3PM) … cost $60.50/contract…net profit at expiration $39.50/contract…ROI 65.3% if EUR/USD finishes over 1.3775

* Both your trading target and the underlying are above your binary strike. The EUR/USD can move minimally until expiration and will finish above the strike, so the binary buyer will receive the $100 payout.

*You’re bullish the market, but the underlying market trading target does not really have any additional benefit other than the binary pricing will move towards the maximum value of $100 sooner.

*Your cost is a higher portion out of the $100 due to the underlying market currently trading 16 pips over the strike price, which is advantageous to the binary buyer.

*Note that if the underlying market is trading at the binary strike price, then the binary pricing should be around $50, which results in neither side of the binary trade receiving an immediate advantage when the trade is initiated.

*This binary strike price is in the money with 16 pips of edge as there is a 60.5% probability of success.  Here the time decay of the binary option actually works in favor of the buyer.

Buy EUR/USD >1.3725 (3PM) … cost $82.00/contract…net profit at expiration $18.00/contract…ROI 22.0% if EUR/USD finishes over 1.3725

* Again this scenario is pretty much the same as the previous strike price. Your trading target and underlying market are both above the strike, but the binary buyer’s immediate advantage is 66 pips.  You have more edge and you’re paying for the advantage.

*You have purchased insurance which results in a reduced ROI; your market bias is icing on the cake but the underlying has room to sell off yet finish above the strike at expiration.

*Again time decay works in favor of the buyer of this strike.

Assume you’re looking for the EUR/USD to have a move in the next 7 hours.

Currently the EUR/USD is trading at 1.3791 and we are making hypothetical trade targets at 1.3910 again for the EUR/USD .

05.22.14 Nadex 2

Buy EUR/USD >1.3900 (3PM) … cost $3/contract…net profit at expiration $97/contract…ROI 3233.3% if EUR/USD finishes over 1.3900

* Our trade target is 1.3910, which is above the strike price, so the underlying market has to rally over 134 pips and finish above the strike price at expiration to receive the $100 expiration value. The binary pricing is giving only a 3% probability that the event outcome will be successful at the time of trade.

* However, by choosing the 1.3900 strike price, you are making things more difficult, because the lower 1.3820 strike price is offered at the same price.

* Buying the EUR/USD >1.3820 (3PM), will save you 80 pips that the underlying market does not have to cover to receive the same payout ratios by using a lower strike.

Buy EUR/USD >1.3800 (3PM) … cost $23/contract…net profit at expiration $77/contract…ROI 334.8% if EUR/USD finishes over 1.3800

* Trading target is 1.3910 which is above your strike price and the underlying market only has to rally over 9 pips to finish above the strike price. Your trade target doesn’t come into your trade decision other than whether you are bullish or bearish, and you obviously think the underlying market will easily exceed the strike price enough to finish in the money at expiration.

*Note that with this strike as a binary buyer, the market is putting a 23% probability of the event outcome at the time of trade

*Your Real Question is will the underlying have the legs to make up +9 pips in 6hours 48minutes?

Buy EUR/USD >1.3780 (3PM) … cost $86/contract…net profit at expiration $14/contract…ROI 16.3% if EUR/USD finishes over 1.3780

* Trading target is 1.3910 which is above your strike price and the underlying market is already over the strike by 11 pips.

*Trade target is not part of this decision, only that you are bullish and the underlying market should finish above the strike at expiration.

* Your cost for this strike is higher in comparison because you’re paying for the 11 pip buyer advantage.

*Binary strike price is in the money, so time decay is a good thing.

Let’s compare two of these previous strategies, which roughly, have the same ROI’s. The 7 hour binary 1.3780 strike price vs the 4 day binary 1.3725 strike price.

  • EUR/USD >1.3725 (3PM) … cost $82.00/contract…net profit at expiration $18.00/contract…ROI 22.0% and has 66 pips of edge for a 4 day option. You pay for the advantage but will it be enough to cover the risk of $82 for 4 days?
  • EUR/USD >1.3780 (3PM) … cost $86/contract…net profit at expiration $14/contract…ROI 16.3% and has 11 pips of edge for a 6 hrs., 48 minute option.  Again, you are paying for the advantage, but it is less time and edge for $86/contract at risk.

Assume you’re looking for the EUR/USD to make a 10 pip move right now! This binary chain will be expiring in 1hour 47minutes.

Currently the EUR/USD is trading at 1.3791.

05.22.14 Nadex 3

Buy EUR/USD >1.3799 (2PM) … cost $13/contract…net profit at expiration $87/contract…ROI 669.2% if EUR/USD finishes over 1.3799

* Our trade target is 1.3801, which is just slightly above the strike price, so the underlying market has to rally over 8 pips at expiration.

*The probability of the trade is 13% and you have 1 hour and 47 minutes for that to come to fruition.

*Given your trade target and strike price, you will probably be in for a wild ride knowing the volatility of the binary pricing. Since the binary is worth $100 or $0 at expiration, the impact of a small % price movement in the underlying market actually will have a much larger % price impact on the binary pricing as expiration nears.

Buy EUR/USD >1.3789 (2PM) … cost $56/contract…net profit at expiration $44/contract…ROI 78.6% if EUR/USD finishes over 1.3789

* The trade target is 1.3801 and the underlying market is only 2pips over the strike price.

*This is an example of an ATM binary where neither the buyer nor seller has much of an advantage/disadvantage when the trade is initiated.

*You are bullish and your anticipated target will give you 12 pips of edge over the strike price in the next 1 hour and 47 minutes. If market doesn’t move, you will find yourself in that ATM roller-coaster ride going into expiration, with $56 of risk.

Buy EUR/USD >1.3779 (2PM) … cost $94/contract…net profit at expiration $6/contract…ROI 6.4% if EUR/USD finishes over 1.3779

* This binary strike price right now has 12pips of edge and you’re already bullish, which could add some additional cushion. If your trade target is at 1.3801, and if this happens within the next 1hour 47minutes, then you have a total of 22pips in edge.

*The probability is very high at 94% right now to be successful, but as you know things can change.

* Your risking $94 to make $6 within the next 1 hour 47 minutes. Does it make sense to you?

  • As you can see, there are many choices on Nadex with the ROI’s at expiration to determine which binary instrument is the best fit, given your underlying market bias.
  • From the examples, it should be clear that there is much to consider.  From the expiration time, the edge that you’re giving or receiving, the ROI, and your underlying market view.
  • Make the effort in understanding the binary nuances, so you can add to your trading arsenal.