A wave of innovation has continued to broaden the world of financial spread betting in recent years. Binary bets are a newer idea, and take spread betting back to the notion of either winning or losing, just as with most regular bets. What they amount to is a bet whether the price will be higher or lower, often by the end of the hour, or by the close of business.
Binary bets in practice offer odds for a yes/no outcome on, say, the FTSE 100 rising in value. There are binaries like no-touch bets, which allow a spread trader to bet that, for instance, whether the Gold price will never trade below $1500 in the next six months.
Binaries and spread bets have a number of common features and work in similar ways to a point. One key difference is because binaries work on the 0-100 scale you always know exactly what the most you can win or lose is, whereas spread betting tends to be more volatile and the potential wins and losses can be greater (although stop losses are applied to markets). In this way traders can speculate with controlled risk on a wide range of shares, index, foreign exchange and commodity movements.
“Binary Bets are simple, and their risk is 100% limited, since the market can’t settle below 0 or above 100.”
Principles
As the name suggests a binary bet can only have two outcomes, an event occurs or an event does not occur. Binaries are commonly applied to financial trading but for the sake of explaining the principles let’s take the case of a fixed odds bet on a football match. So whereby betting fixed odds on a football match for example there are three outcomes – team A wins, team B wins or it’s a draw, with binary betting there are two outcomes for each of these three options.
Market one is: Team A wins/Team A does not win
Market two is: The Match is a draw/the match is not a draw
Market three is: Team B wins/Team B does not win
If an event happens the binary market is settled at 100, if the event does not happen it is settled at 0. Thus there are always two prices with a binary bet. Staking with binary betting is more akin to spread betting in that it is leveraged product (albeit within a set range of 0-100).
“The most popular binary betting markets tend to be the FTSE index, Dow and the euro/dollar currency cross”
Binary Betting Example:
Suppose that the time is 9.30am and the FTSE 100 has already gained 36 points on yesterday’s closing level for the FTSE 100. The UK FTSE 100 Up Binary bet price is currently being quoted at 64.2 / 67.4
In this instance if you expected the FTSE 100 to close at a higher price than yesterday’s closing price, you might open a ‘buy’ position of £20 per point at 67.4. Unlike spread betting and CFDs, binary betting caps your profit and loss potential, so you would already know that in the worst case scenario you would lose £1348 (0 – 67.4 x £20). Similarly you would know that you maximum gain would amount to £652 (100 – 67.4 x £20).
So suppose that after going long on the FTSE and waiting a few hours we note that the FTSE 100 is ‘stuck’ range trading but is still up by 40 points. The FTSE 100 Up Binary bet price is now trading at 80 / 83.8. Seeing that your bet is in profit, you decide to pick your profits by selling £20 per point at 80.0 (a 12.6-point movement from 67.4 in your favour). On the other hand you might decide to keep holding the trade until the very close of trading for which the bet would settle at 100 (if the FTSE remained up representing a 32.6 point movement on your original position). More information on binary betting here.
Potential for Profit
In practice the most popular markets for binaries tend to be the main stock indices and currency pairs, such as the FTSE 100 and the euro/dollar. Binaries are however also offered on some commodities like oil, gold and silver.
Most traders like volatility as it provides more opportunities for profit and binary options in particular allow for very short-term trades. In fact there are even 60-seconds binary trades that are designed for a quick punt. But these may not be the best choice for beginners 1) because of the randomness factor over such very short-timeframes 2) because you need a very good understanding of technical and key levels when trying to trade on an intraday basis. Let’s say that the USA markets have moved up sharply overnight and that the next day the FTSE 100 opens strongly up 50 points. A binary trade for this market to finish the day down may be trading at just ’20 to buy’, since the market has rallied so much early on and so the likelihood of it reversing is low – even if such reversals are possible particularly in turbulent market conditions. In this instance a binary trader could buy £2 per point at 20, risking just £40 if the market finishes the trading day in positive territory (binary will settled at zero in this scenario). However, the potential reward is £160 should the market reverse and end up finishing slightly down (binary settles at 100).
Interview with Angus, an Industry Insider
Spread-Betting.com: Tell us why you decided to plunge into the binary betting business?
Angus: To create volatility in otherwise un-volatile markets and to be able to offer a wider range of products.
Financial-Spread-Betting: Binary betting are just one type of a new generation of options, called exotic options, that has emerged in the last 5-10 years. Could you give us an overview of binaries exotic options? How do they work? How does binary betting differ from fixed odds and spread betting?
Angus: Binaries are an exciting product as you will always know your downside since you know your potential losses and profits as and when you open a position. A binary market is made between 0 (the event not happening) and 100 (the event happening). For example, we have a binary bet on whether ABC plc share price (400p) will close up or down on the day. If it closes up the Binary mkt will close at 100 and down at 0. The market is titled “ABC PLC up on the day” At the opening of the day the market will trade at 48 – 52 (which means it’s 50/50 as to the outcome) you’d buy @ 52 if you agree that it will end up on the day or sell at 48 you disagree. The day progresses and ABC announce some good news which rallies the share price upwards and therefore the market settles at 100. If you bought at 52 your bet will close out at 100 which will give you a return of (100-52) = 48 x your stake. If you had sold at 48, disagreeing with the market then you’d have lost (100-48) = 52 x your stake.
With a spread bet you only get the movement of the share value, i.e 400p to 410p you are in theory, liable to all 400 pence times your stake, should the market crash, though there are many sophisticated tools that providers supply that can limit your potential losses on spread betting. Binaries, unlike fixed odds are easy to enter and exit whenever you want. Spread betting is great for directional punts but it comes with the risk of getting stopped out if you couple a trade with a stop loss. If for instance you were uncertain about the direction of the FTSE in the next few hours but expecting the index to end down, you could take a one-day binary for the market to finish down. You would know your maximum risk from the outset without having to worry about stops.
Spread-Betting.com: To whom do you think will binary betting products appeal most?
Angus: Clients who like to know their potential risk and their reward. Also when markets are trading flat, binaries spice up the market volatility and therefore offering opportunity in otherwise flat markets.
Spread-Betting.com: Could you give us some insight about how a binary bet is priced? How are you able to price/offer forex options with such short term “target” time frames? Do you use the Black and Scholes model for pricing bets? Do you use formulas to price bets?
Angus: The fundamental principal of pricing model used is Black and Scholes, but there are many more parameters used so it’s not as simple as you’d think!
Spread-Betting.com: What uses do binary bets have? Please explain with examples.
Angus: They provide volatility in flat markets and limited risk the moment you trade.
Spread-Betting.com: Are gains/winnings taxable?
Angus: No, as they are classified as a bet!
Spread-Betting.com: Will you stop clients who are day-trading effectively?
Angus: No. We have encountered traders who have worked hard to develop systems that were consistently profitable only to find that the platform broker abruptly changed the rules thus killing their trading systems or worse barred the users. Please comment.
We hedge our positions so do not mind winning clients. As long as they are not abusing the system and trading on clearly incorrect prices to give them an unfair advantage we welcome winning clients with open arms. A winning client is a happy client and we hope that then continue to trade with us for the long-term.
Spread-Betting.com: As of now, what trends do you see in the markets people choose to trade? Are there certain markets that clients seem to prefer? Do you think this will change over time?
Angus: Popular markets are: indices (primarily Dow and FTSE) commodities, (oil mostly) and currency markets. We also see a huge amount of business in shares. We traded the equivalent of over 1 billion shares last year alone!
Spread-Betting.com: Any ideas on trading the short-term binaries?
Global happenings and USA data like the monthly non-farm payrolls or home sales figures can lead to immediate sharp market moves which may subsequently reverse as market participants digest the news. This could provide opportunities for binary traders to take very short-term punts.
Spread-Betting.com: Are there traders who make a living through trading? What is the trading style and methods that these traders use for winning consistently?
Angus: There are plenty of clients who are making a living through trading with us and their strategies range from day trading to trend trading.
Spread-Betting.com: The last few years has seen an explosion in spread betting, cfds and more recently binary betting. Do you think it could spell the end of traditional share trading? And is the stock market feeling the pinch?
Angus: No, it will not spell the end of share trading as there are still 7.5 million share traders out there and at the best only 300k spread betters/binary betters. As it is a leveraged product it is riskier. There are still bad connotations regarding the industry due to the fact that it is classified as a bet, but then it wouldn’t be tax free! People are gradually coming round to the idea and realizing that they get exactly the same exposure through SBs as you do with traditional stock brokers. The market can only do one of 2 things – go up or down, so whether you do it through us or a normal broker, you get the same result.
Spread-Betting.com: There are many sayings in the markets; do you have a favourite one?
Angus: If you find yourself itching to get in the market it is often time to stay out. This can lead to irrational decisions and cost you.