Binary Options Strategies for Directional and Volatility

Binary
Options

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Binary
Options

Strategies for
Directional and
Volatility Trading

ALEX NEKRITIN

John Wiley & Sons, Inc.

Cover Design: John Wiley & Sons, Inc.
Cover Image: (c) Andy Hair/iStockphoto

Copyright © 2013 by Alex Nekritin. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

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Library of Congress Cataloging-in-Publication Data:

Nekritin, Alex, 1980–
Binary options : strategies for directional and volatility trading / Alex Nekritin.
p. cm.—(Wiley trading series)
Includes index.
ISBN 978-1-118-40724-0 (cloth); ISBN 978-1-118-41777-5 (ebk);
ISBN 978-1-118-52868-6 (ebk); ISBN 978-1-118-42182-6 (ebk)
1. Options (Finance) 2. Futures. I. Title.
HG6024.A3N448 2013
332.64'53—dc23
2012032301

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

This book is dedicated to my parents, Nina and Boris Nekritin.
Thanks for all your unconditional love and support.
Without you, none of this would have been possible.

Contents

Foreword xi
xiii
Preface xvii

Acknowledgments 1

PART I Introduction to Binary Options 3
3
CHAPTER 1 What Are Binary Options? 10
13
On What Asset Classes Are Binary Options Available? 14
Binary Options vs. CBOE (Vanilla) Put/Call Options
Advantages/Disadvantages of Binary Options 17
Reasons to Trade Binary Options
19
PART II Binary Options Theory 20
22
CHAPTER 2 What Does Binary Mean? 24

Components to a Binary Option 29
Long Trading 29
Short Trading 30
32
CHAPTER 3 Pricing 35

Strike Price vii
Time Value
Price as a Natural Market Consensus
Reading a Binary Option Chain

viii CONTENTS

PART III Trading Binary Options 41

CHAPTER 4 Binary Options Contract Collateral 43

Margin and Debit Risk of Vanilla Options and Futures 43
Collateral Explained 44
Binary Options Expiration Values 44
Collateralizing a Long Trade 45
Collateralizing a Short Binary Options Trade 50
The Mechanics of a Binary Options Short Trade 50

CHAPTER 5 Settlement 59

Settlement on Binary Option Long Trades 59
Commissions and Fees 73

CHAPTER 6 Entering and Exiting Binary Option Trades 75

Reading Quotes 75
Reading an Order Ticket 76
Exiting Trades 78
Exiting Your Trade before Expiration 81

CHAPTER 7 Keys to Trading Binary Options 95
and More Examples
96
Gold Binary Examples 99
Copper Binary Examples

PART IV Binary Options Trading Strategies 105

CHAPTER 8 Volatility Trading Explained 107

Taking a Volatility Long Position (Buying Volatility) 108

Regulating Success Probability and Payout with Strike Prices 111

Taking a Volatility Short Position (Selling Volatility) 113

Regulating Range and Payout with Strike Prices 116

Max Loss, Collateral, and Max Profit Summary Table 120

Contents ix

CHAPTER 9 Binary Option Behavior as 123
Expiration Approaches 123
127
Understanding Delta
Delta and Price 129
130
CHAPTER 10 Technical Trading Strategies with 135
Binary Options
139
Support and Resistance 139
Breakout Trading 144
147
CHAPTER 11 Fundamental Trading Strategies 149
with Binary Options
153
News Releases
Political Events 155
Speculating on Actual News Releases 155
Economic Data Releases that You Can Speculate On 156
158
PART V Creating Your Binary Options Strategy 162

CHAPTER 12 Systems with Binary Options 165
166
Finding Your Edge 166
Proper Trading System Development 168
Back-Testing Binary Options Strategies 175
Three Back-Testing Rules
183
CHAPTER 13 Negative Emotions 184
185
Greed and Fear
How to Handle Negative Emotions
Find the Right System for You
Practical Steps to Mitigate the Negative Emotions

CHAPTER 14 Risk Management

The Process
Determining Position Size

x CONTENTS

Risk Management on Option Spreads 190
Relationship between Position Size and Trading Psychology 199
Handling Unexpected Market Volatility 199
Benefits of Binary Options on Trading Psychology 202
Discipline of Expiration 206

PART VI Managing Your Binary Options Account 209

CHAPTER 15 Proactive System Improvement 211

System Cutoffs 212
Drawdown 212
Consecutive Losing Trades 215
Reinvestment Rate 216
Diversification and Account Distribution 220
Intersystem Diversification 220
Account Breakdown 221

PART VII Profiting with Volatility 223

CHAPTER 16 The Volatility Short Trading Rules 225

Premium Collection 226
Rule 1: Cut Off Your Losing Trades 231
Rule 2: Collect Enough Premium 234
Rule 3: Sell Far Enough Away from Market Price 240
Rule 4: Use Underlying Instruments that Revert to the Mean 242
Rule 5: Sell Options with Proper Duration until Expiration 244
Rule 6: Perform Additional Analysis in Order to Get a
246
Feel for Market Direction 255
Rule 7: Attempt to Make Your Market 256
Conclusion

Glossary 259

Index 263

Foreword

B inary options are a relatively new and unique way to take part in the
financial markets. Over the past decade they have become popular
instruments in Europe and Asia, and more recently, over the past few
years, have not only gained acceptance, but have seen widespread growth
in the United States, particularly within the retail trading community.

One may ask, “Why, with all of the investment vehicles available,
stocks, futures, forex, options, exchange‐traded funds, and so on, would I
want to take a look at another contract type?” This is a legitimate question.

One of the main reasons traders may look to a contract like a binary
option is risk control. Any seasoned trader in any market knows that profit-
ability on any given trade is secondary, but risk management on every trade
is mandatory and of the utmost concern. This is particularly true when par-
ticipating in leveraged markets such as futures and currencies, where one
mistake can not only result in large losses, but in some cases, losses that
exceed the amount of capital in the trader’s account. This can create an
ugly scenario for any trader—the dreaded margin call. If you’re not famil-
iar with this concept, just think of the reaction of Randolph and Mortimer
Duke at the end of the movie Trading Places and you may have a good idea
of the devastating effect a margin call can have.

In the case of a binary option, whether I am buying or selling, my risk
is always limited and 100 percent defined up front, before the order is sub-
mitted. What this means is that a trader can very closely manage the risk
on every trade. No matter what happens in the world while the trade is
on—geopolitical tensions, central bank announcements, natural disasters,
whatever the case—the investor cannot lose more than is put up for the
trade. No worries of margin calls or being margined out, and more impor-
tantly, no chance of your broker calling you up and telling you that you
have to deposit more funds—funds that you may not have.

Another reason to consider binary options is simply cost. Many of you
reading this may have wanted to speculate in the financial markets. You
may have been standing at the gas pump and thought, “I knew oil was go-
ing up.” Or perhaps you were reading the newspaper, saw something that
caught your eye, and said, “I think stocks are going up tomorrow.” Unfortu-
nately for many, the cost of placing a trade in the traditional markets may

xi

xii FOREWORD

just be too great. Whether it be because of large margin requirements, or
the risk of trading a single contract alone is just too great, you’ve been shut
out of the trading community.

If that is the case, binary options, because of the low barrier to en-
try, may offer you the opportunity to participate in markets you otherwise
wouldn’t have access to. Most importantly, you can now take part in these
markets while protecting yourself through the limited risk nature of these
contracts. Additionally, if you are a seasoned trader, you may look to binary
options as an alternative vehicle, giving you opportunity to trade in situa-
tions you otherwise wouldn’t take in the more traditional markets.

You may be saying to yourself, this sounds really good, but if it is so
good, why isn’t everyone doing this?

Well, one reason is that trading, in any market, is not easy. It is a skill
and, like any skill, takes time to develop. It is a path that one should start
down slowly, and trading, in and of itself, is a never‐ending process of
learning and trying to improve.

Another reason binary options have not become a household name is
simply that as a relatively new trading vehicle, there has been a severe lack
of quality material on the subject. Some information has been available;
however, it often took a great deal of digging to find it, and when one did,
it could be difficult to piece it all together and assemble into a sensible
format.

Thankfully, with the publication of Alex’s work on binary options, this
hindrance has become a thing of the past. The following pages in this book
provide a clear, concise guide to trading binary options. In a way, it is hard
for me to call this just a “book.” It is in fact a complete user manual, provid-
ing a step‐by‐step guide to trading binary options. Starting with the very ba-
sics and moving all the way through to advanced strategies, it offers what
will undoubtedly be a very valuable reference for traders of all levels.

Whether you’ve never placed a binary options trade—or, for that mat-
ter, a trade in any market—this course will give you a solid foundation from
which to enter the market with a full understanding of mechanics, price
movement, and, most important, risk.

Even if you’re an experienced binary options trader, this work will
likely provide new ideas and strategies to enhance your current trading
methodology. Even though I have studied binary options for several years,
the material covered here gave me new concepts to explore and opened my
eyes to looking at familiar concepts in a whole new light.

I hope you enjoy this work as much as I do and wish you much success
in all your endeavors.

Dan Cook
September 2012

Preface

E xchange‐traded binary options are fixed‐risk/fixed‐reward instru-
ments that are fairly simple to trade. They are distinctly different
from regular vanilla put/call options and they absolutely should not
be confused with over‐the‐counter binary options. In this guide, we will
cover what sets exchange‐traded binary options apart and explain to you
in great detail how they work.

Please read this guide very carefully and follow along with the ex-
amples provided. The text is deliberately packed with a ton of examples,
some of which may seem repetitive to you. The idea behind this is that
once you go through enough examples, you will be able to grasp the con-
cept. In order to solidify the concepts even further, you can visit www
.traderschoiceoptions.com for more trade examples and even quizzes.
Once you are clear on the concept, you may find binary options to be sim-
ple to implement. You will also see that they have certain unique and clear
advantages that provide for potentially great trading opportunities.

This guide is beneficial for beginner, intermediate, and advanced trad-
ers who are not familiar with binary options.

If you are a beginner, all concepts are diligently explained, and you will
find a detailed glossary to cover all trading‐related terms that you may or
may not be familiar with. You certainly don’t need to be a mathematics gen-
ius to trade binary options. The only type of math really involved is basic
addition and subtraction. You really need to understand the concept, and
the rest will be easy, fun, and potentially rewarding—although, as with all
types of trading, there are always risks.

If you are an intermediate or an advanced trader, you should be able to
pick up the theory behind binary options pretty quickly. You may still want
to take a look at the basic sections of this guide, as the concepts that we
introduce build on one another. You should put a great deal of focus on the
sections that explain the theory and practice behind binary options. Once
you go through a number of examples and learn the key attributes of binary
options, you will see how they have certain unique features that, if used
correctly, can provide you with many great trading opportunities. By using
this guide with a demo trading account, you should be well on your way to
taking advantage of this great trading instrument.

xiii

xiv PREFACE

After completing this intro course, you may want to take a look at our
strategy guide at www.traderschoiceoptions.com to give you some inter-
esting trading strategies and systems that you can use with binary options.

The course is broken down into sections, and each section builds on
the previous one. The best way to approach this guide is to read it in order.

PART 1: INTRO TO BINARY OPTIONS

Here, you will learn the basics, like: What are binary options? Where are
they traded? What instruments are they traded on? How safe is your money
when you are trading them? How do they differ from other kinds of op-
tions?

PART 2: BINARY OPTIONS THEORY

Here, you will learn the theory behind binary options and how you can use
them to speculate on the markets. Among other aspects, you will cover
margin/collateral, expiration times, the mechanics of strike prices, and
how to read a binary option chain. Once you are clear on the concepts, you
can follow our trade examples to make sure that you understand the logic
behind binary options trades.

PART 3: TRADING BINARY OPTIONS

Here, you will learn how to actually trade binary options. You will learn
how to read price quotes and order tickets and how to enter and exit posi-
tions. You will learn the transaction costs associated with binary options
trading and will walk through placing a trade. Once you are clear on these
concepts, you can go through more trade examples to make sure that you
are ready to start trading binary options.

PART 4: BINARY OPTION TRADING STRATEGIES

Here, you will learn some directional and volatility trading strategies with
binary options using both technical and fundamental analysis. With direc-
tional trading, you can simply speculate on the underlying asset’s price to
move in one direction or another.

Preface xv

The great factor of volatility trading strategies is that you can specu-
late on the underlying asset to stay within a certain range or go outside of
a range by expiration. This allows you a lot more options and flexibility in
your trading strategies. In order to trade volatility vanilla put/call options,
trading accounts require relatively high deposits; however, binary options
open up the world of volatility trading to you with only a $100 deposit for
every contract traded.

PART 5: CREATING YOUR BINARY OPTIONS STRATEGY

Here, you will learn all about how binary options can be extremely benefi-
cial for setting up a trading system. Binary options can help mitigate the
effects of emotion and make calculating potential risks and rewards very
straightforward. In addition, this section will teach you about some of the
basic trading strategies that you can use with binary options. Long, short,
range‐bound, breakout‐bound—the list goes on and on. The advantages of
trading binaries are endless.

PART 6: MANAGING YOUR BINARY OPTIONS ACCOUNT

Here, you will learn that, as with any trading account, there is a large amount
of work involved with a binary options account. However, it doesn’t have to
be very difficult or stressful if you follow our guidelines to control your risk
and protect your gains. This section will teach you about many aspects of
risk management as they pertain to binary options. Before you start trad-
ing, be sure to study this section.

PART 7: PROFITING WITH VOLATILITY

Here, you will learn about one of the most potentially profitable ways to trade
binary options: premium collection. This allows you to make money off of in-
struments doing what they often already do: staying where they are. By using
our descriptions of both the basics and the complexities of premium collec-
tion, you can set up a trading system that is reliable, robust, and successful.

So strap yourself in and get ready to learn about a new trading instrument
that can provide you with endless possibilities and great opportunity.

Acknowledgments

F irst of all, I want to thank my father, Boris Nekritin, for getting me in
the trading game many years ago. Without him, I would never have
accomplished even one tenth of what I have accomplished, and I
certainly would never have been able to write this book. There are many
other people who deserve acknowledgment; the list includes but is not lim-
ited to the following: Dan Antonuccio, for pretty much managing all of my
projects and, as usual, putting everything together to turn my ideas into
reality; Eddie Kwong, who is a great friend and one of the most connected
guys I know in the trading industry, for putting me in touch with Wiley and
teaching me a ton about the business; Dan Cook, who is the real expert in
binaries, for patiently answering all of my complex questions about the
product; Abe Cofnas, who is one of the most knowledgeable and enthu-
siastic traders I have met, for getting me excited about binary options in
the first place; Patrick Tobin and Even Nelson, who were a lot of help with
the writing and many of the images in the book; the team at Wiley—Evan
Burton, Meg Freeborn, and Simone Black—for believing in the idea and
making the book a reality. Of course, my parents Nina and Boris Nekritin
for unconditional love and support in everything I do. And last, but cer-
tainly not least, my fiancée, Kendra, for helping me stay focused with her
love and support.

xvii

Binary Options: Strategies for Directional and Volatility Trading. Alex Nekritin.
© 2013 Alex Nekritin. Published 2013 by John Wiley & Sons, Inc.

PART I

Introduction to
Binary Options

T his section will provide you with an overview and discussion of the
main benefits of binary option trading.
What You Will Learn:
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ing of what binary options are and be familiar with their main advantages.

1

Binary Options: Strategies for Directional and Volatility Trading. Alex Nekritin.
© 2013 Alex Nekritin. Published 2013 by John Wiley & Sons, Inc.

CHAPTER 1

What Are
Binary Options?

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options. They are derivative instruments that can be considered a
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#JOBSZ PQUJPOT BSF DPOTJEFSFE CJOBSZ CFDBVTF UIFSF BSF POMZ UXP QP
tential outcomes at expiration: 0 or 100; 0 and 100 refer to the settlement
value of a binary option and could be viewed in dollars. At expiration, if
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BOE JG ZPV BSF DPSSFDU

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tlement value of binary options.

ON WHAT ASSET CLASSES ARE BINARY
OPTIONS AVAILABLE?

Binary options are available on four different asset classes. These include
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leases. This section will explain the basics of what each of the asset classes
BSF BOE IPX UIFZ XPSL

Before we explain the different futures asset classes, it is important to
first understand what futures are. A future is a contract that says that the
buyer or seller will purchase or sell a specific asset for a specific price at
a specific time in the future. Investors trade futures contracts to speculate
for profit and to hedge their assets. One of the benefits of trading futures
is that traders don’t have to physically buy a certain commodity in order to

3

4 BINARY OPTIONS

speculate on its price movements. They can simply enter their trade with a
smaller amount of cash on margin.

Futures contracts are traded on an exchange, and their price typically
moves with the price of the underlying asset. Since traders are speculat
ing on a future price of an asset, the futures price can be slightly higher or
lower than the spot price.

All futures contracts have specific expiration dates that vary by the as
set class on which the futures contract is based.

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you believe the price is going to increase. Instead of buying physical
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JOH UIF GVUVSFT QVSDIBTF QSJDF GSPN UIF GVUVSFT TBMF QFS P[
PS
o
For a trader, using futures on margin is a lot more convenient than
actually buying and holding physical goods.
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.net.

Stock Index Futures

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buy an entire index on margin, which is much more convenient.

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UJNF
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of a futures contract is good only until the expiration date, on which the
particular futures contract can no longer be traded.

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option an assumption is made that at the end of the day the futures price
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What Are Binary Options? 5

correct in your assumption, your binary option contract yields a profit. The
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tions of this guide.

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t Wall Street 30 (Dow Futures). Futures based on the Dow Jones
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BO JOEFY
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/:4& PS UIF /BTEBR

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JOEFY 5IF /BTEBR JT BO JOEFY DPNQPTFE PG UIF MBSHFTU
NPTU
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UFDI TUPDLT BSF USBEFE

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GPSNBODF PG
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BOE
in this case the companies are small.

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TUPDLT
PO UIF -POEPO 4UPDL &YDIBOHF

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5IF %"9 JT BO JOEFY PG UIF MBSHFTU (FSNBO DPNQBOJFT USBEFE PO
UIF 'SBOLGVSU 4UPDL &YDIBOHF

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JOEFY 5IF /JLLFJ JOEFY JT NBEF VQ PG +BQBO T UPQ DPNQBOJFT
PO UIF 5PLZP 4UPDL &YDIBOHF

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JOEFY
XIJDI JT NBEF VQ PG UIF MBSHFTU DPNQBOJFT PO UIF ,PSFBO
&YDIBOHF

Commodity Futures

Commodities are physical goods, such as oil, corn, or gold. Commodity
futures are a financial instrument that can be used to speculate or hedge on
various physical commodities.

Commodity futures are usually priced slightly higher than the spot
commodity in order to account for the convenience that the futures offer
to the trader. Commodity futures are exchange traded and typically change
along with the price of the underlying.

6 BINARY OPTIONS

-FU T UBLF B MPPL BU B CJOBSZ PQUJPO USBEF PO B DPNNPEJUZ GVUVSF
-FU T TBZ UIBU HPME GVUVSFT BSF DVSSFOUMZ USBEJOH BU QFS P[ BOE
ZPV UIJOL UIF HPME GVUVSFT BSF HPJOH UP SFBDI MBUFS UPEBZ :PV DBO CVZ
POF EBJMZ HPME CJOBSZ PQUJPO DPOUSBDU XJUI B TUSJLF QSJDF PG 8JUI UIJT
binary option an assumption is made that at the end of the day the futures
price will be above 1100. At the end of the day the gold futures are trading
at 1100 and your binary options contract yields a profit.
Binary options are available on the following commodity futures:

t Crude oil futures. Futures contracts based on current price if you were
to buy or sell physical crude oil. Crude oil is the commodity that is used
to produce heating oil and gasoline. Crude oil futures have contracts
that expire each calendar month.

t Natural gas futures. Futures contracts based on the current price if you
XFSF UP CVZ PS TFMM BDUVBM OBUVSBM HBT /BUVSBM HBT JT VTFE UP IFBU IPNFT
/BUVSBM HBT GVUVSFT IBWF DPOUSBDUT UIBU FYQJSF FBDI DBMFOEBS NPOUI

t Gold futures. Futures contracts based on the current price if you were
UP CVZ PS TFMM QIZTJDBM HPME 1IZTJDBM HPME JT VTFE UP NBLF KFXFMSZ BOE
JT BMTP VTFE JO NBOVGBDUVSJOH (PME GVUVSFT IBWF DPOUSBDUT UIBU FYQJSF
in February, April, June, August, and December.

t Silver futures. Futures contracts based on current price if you were to
CVZ PS TFMM QIZTJDBM TJMWFS 1IZTJDBM TJMWFS JT VTFE UP NBLF KFXFMSZ BOE
is also used in manufacturing. Silver futures have contracts that expire
in March, May, July, September, and December.

t Copper futures. Futures contracts based on the current price if you
were to buy or sell physical copper. Physical copper is used in elec
tronics, manufacturing, and architecture. Copper futures have con
tracts that expire in March, May, July, September, and December.

t Corn futures. Futures contracts based on the current price if you were
to buy or sell physical corn. For the most part, the corn on which these
GVUVSFT BSF CBTFE JT VTFE UP GFFE MJWFTUPDL $PSO GVUVSFT IBWF DPOUSBDUT
that expire in March, May, July, September, and December.

t Soybean futures. Futures contracts based on the current price if you
XFSF UP CVZ PS TFMM QIZTJDBM TPZCFBOT 4PZCFBOT BSF UVSOFE JOUP DPPLJOH
PJM BOE ýPVS
BOE DBO CF VTFE UP GFFE MJWFTUPDL 4PZCFBO GVUVSFT IBWF
contracts that expire in January, March, May, July, August, September,
BOE /PWFNCFS

:PV DBO åOE NBOZ HSFBU XFCTJUFT UP WJFX DIBSUT PG WBSJPVT GVUVSFT
DPOUSBDUT BOE BMTP TUSFBNJOH RVPUFT XXX CBSDIBSU DPN JT BO FYDFMMFOU
free charting website that will display delayed price charts of almost every
EJGGFSFOU BTTFU DMBTT
GSPN TUPDLT UP DPNNPEJUZ GVUVSFT

What Are Binary Options? 7

www.forexpros.com/ is an excellent resource that allows you to view free
TUSFBNJOH RVPUFT GPS BMNPTU FWFSZ BTTFU DMBTT JODMVEJOH TUPDLT BOE GVUVSFT

Spot Forex

#FGPSF HPJOH JOUP FYBNQMFT PG CJOBSZ PQUJPOT PO TQPU NBSLFUT
ZPV TIPVME
CF DMFBS PO XIBU B TQPU NBSLFU JT 5IF TQPU NBSLFU PS DBTI NBSLFU JT B QVC
MJD åOBODJBM NBSLFU JO XIJDI åOBODJBM JOTUSVNFOUT TVDI BT DVSSFODZ BOE
CPOET
PS DPNNPEJUJFT MJLF HPME BOE TJMWFS
BSF USBEFE 5IF TQPU NBSLFU JT
DBMMFE UIF iDBTI NBSLFUw PS iQIZTJDBM NBSLFUw CFDBVTF QSJDFT BSF TFUUMFE
JO DBTI PO UIF TQPU BU DVSSFOU NBSLFU QSJDFT *O FTTFODF
UIF TQPU NBSLFU
DPVME CF DPOTJEFSFE B NBSLFU XIFSF HPPET BSF USBEFE CBTFE PO UIF QSJDF JO
UIF NBSLFU SJHIU OPX BOE BSF CPVHIU BOE TPME JNNFEJBUFMZ

Spot forex is the abbreviation for the foreign exchange or currency
NBSLFU 5IF GPSFY NBSLFU JT DPOTJEFSFE B TQPU NBSLFU " TQPU NBSLFU JT BOZ
NBSLFU UIBU EFBMT JO UIF DVSSFOU QSJDF PG B åOBODJBM JOTUSVNFOU 3FUBJM TQPU
GPSFY JT USBEFE WJB GPSFY EFBMJOH åSNT BOE CBOLT

0OF XBZ UP MPPL BU GPSFY USBEJOH JT UIBU ZPV BSF FGGFDUJWFMZ TQFDVMBUJOH
on the economies of various countries.

$VSSFODJFT BSF BMXBZT RVPUFE JO QBJST
TVDI BT (#1 64% PS 64% +1:
5IF SFBTPO UIFZ BSF RVPUFE JO QBJST JT UIBU JO FWFSZ GPSFJHO FYDIBOHF USBOT
action you are simultaneously buying one currency and selling the other.
)FSF JT BO FYBNQMF PG B GPSFJHO FYDIBOHF SBUF GPS UIF #SJUJTI QPVOE WFSTVT
UIF 6 4 EPMMBS (#1 64%

5P TFF SFBM UJNF GPSFY RVPUFT
WJTJU XXX USBEFSTDIPJDFPQUJPOT OFU
4FF &YIJCJU

5IF DVSSFODZ MJTUFE UP UIF MFGU PG UIF TMBTI i w
JT LOPXO BT UIF CBTF
DVSSFODZ JO UIJT FYBNQMF
UIF #SJUJTI QPVOE

XIJMF UIF POF PO UIF SJHIU JT
DBMMFE UIF RVPUF DVSSFODZ JO UIJT FYBNQMF
UIF 6 4 EPMMBS


8IFO CVZJOH
UIF FYDIBOHF SBUF UFMMT ZPV IPX NVDI ZPV IBWF UP QBZ
JO VOJUT PG UIF RVPUF DVSSFODZ UP CVZ POF VOJU PG UIF CBTF DVSSFODZ *O UIF

GBP/USD = 1.7500

Base Currency Quote Currency

EXHIBIT 1.1 Advantages and Disadvantages of Binary Options

8 BINARY OPTIONS

QSFDFEJOH FYBNQMF
ZPV IBWF UP QBZ 6 4 EPMMBST UP CVZ POF #SJUJTI
pound.

8IFO TFMMJOH
UIF FYDIBOHF SBUF UFMMT ZPV IPX NBOZ VOJUT PG UIF
RVPUF DVSSFODZ ZPV HFU GPS TFMMJOH POF VOJU PG UIF CBTF DVSSFODZ *O UIF
FYBNQMF
ZPV XJMM SFDFJWF 6 4 EPMMBST XIFO ZPV TFMM POF #SJUJTI
pound.

-FU T MPPL BU BO FYBNQMF PG B CJOBSZ PQUJPOT USBEF PO TQPU GPSFY
-FU T TBZ UIBU UIF &63 64% JT DVSSFOUMZ USBEJOH BU :PV UIJOL UIF
FVSP JT HPJOH UP EFQSFDJBUF HP EPXO
JO WBMVF SFMBUJWF UP UIF 6 4 EPMMBS BOE
XJMM EFDMJOF UP MBUFS UPEBZ :PV EFDJEF UIBU ZPV XBOU UP UBLF B QPTJ
UJPO PO UIF &63 64% CZ TFMMJOH POF EBJMZ &63 64% CJOBSZ PQUJPO DPOUSBDU
XJUI B TUSJLF QSJDF PG 8JUI UIJT CJOBSZ PQUJPO BO BTTVNQUJPO JT NBEF
UIBU BU UIF FOE PG UIF EBZ UIF &63 64% XJMM CF USBEJOH CFMPX "U UIF
FOE PG UIF EBZ UIF &63 64% JT USBEJOH BU #FDBVTF ZPV XFSF DPSSFDU
in your assumption, your binary option contract yields a profit.
Binary options are available on the following currency pairs:

t AUD/USD. 5IF FYDIBOHF SBUF CFUXFFO UIF "VTUSBMJBO EPMMBS BOE 6 4
dollar.

t EUR/USD. 5IF FYDIBOHF SBUF CFUXFFO UIF FVSP BOE 6 4 EPMMBS
t EUR/JPY. The exchange rate between the euro and Japanese yen.
t GBP/JPY. The exchange rate between the British pound and

Japanese yen.
t GBP/USD. 5IF FYDIBOHF SBUF CFUXFFO UIF #SJUJTI QPVOE BOE 6 4

dollar.
t USD/CAD. 5IF FYDIBOHF SBUF CFUXFFO UIF 6 4 EPMMBS BOE $BOBEJBO

dollar.
t USD/CHF. 5IF FYDIBOHF SBUF CFUXFFO UIF 6 4 EPMMBS BOE 4XJTT GSBOD
t USD/JPY. 5IF FYDIBOHF SBUF CFUXFFO UIF 6 4 EPMMBS BOE +BQBOFTF ZFO

Economic Data Releases

#JOBSZ PQUJPOT DPOUSBDUT BSF BMTP BWBJMBCMF PO LFZ FDPOPNJD EBUB SFMFBT
es. Before we go into examples of binary options on economic events, we
TIPVME åSTU EJTDVTT XIBU XF NFBO CZ iFDPOPNJD FWFOUTw BOE
NPSF JNQPS
tant, what an economic event is.

8IBU BSF FDPOPNJD FWFOUT 5ISPVHIPVU UIF ZFBS UIF 6 4 HPWFSONFOU
JTTVFT WBSJPVT SFQPSUT UIBU EFUBJM UIF PWFSBMM IFBMUI PG UIF 6 4 FDPOPNZ
5IFTF SFQPSUT BSF SFMFBTFE CZ EFQBSUNFOUT PG UIF 6 4 HPWFSONFOU BOE SF
WPMWF BSPVOE TFWFSBM DPNQPOFOUT UP UIF 6 4 FDPOPNZ 4PNF PG UIFTF DPN
QPOFOUT BSF DPOTVNFS TQFOEJOH XIFUIFS PS OPU QFPQMF BSF CVZJOH HPPET


KPCMFTT DMBJNT UIF OVNCFS PG DVSSFOU VOFNQMPZFE JOEJWJEVBMT

MBCPS SF
QPSUT XIFUIFS DPNQBOJFT BSF IJSJOH

BOE JOUFSFTU SBUFT UIF JOUFSFTU SBUFT
CBOLT DIBSHF GPS MPBOT

What Are Binary Options? 9

www.forexfactory.com is a great resource to learn more about eco
nomic events.

-FU T UBLF B MPPL BU B CJOBSZ PQUJPOT USBEF PO BO FDPOPNJD FWFOU
-FU T TBZ UIBU ZPV BSF JOUFSFTUFE JO UBLJOH B QPTJUJPO PO UIF KPCMFTT
DMBJNT SFQPSU UIBU XJMM CF DPNJOH PVU PO 5IVSTEBZ :PV UIJOL UIBU GFXFS
QFPQMF IBWF åMFE GPS VOFNQMPZNFOU CFOFåUT BOE UIBU UIF KPC NBSLFU BT B
XIPMF IBT CFFO JNQSPWJOH -BTU XFFL
OFX VOFNQMPZNFOU DMBJNT
XFSF åMFE
BOE ZPV GFFM UIBU UIJT XFFL UIF OVNCFS XJMM CF MFTT :PV TFMM POF
KPCMFTT DMBJNT CJOBSZ PQUJPO XJUI B TUSJLF QSJDF PG

8JUI UIJT CJOBSZ PQUJPO UIF BTTVNQUJPO JT NBEF UIBU PO 5IVSTEBZ UIF
KPCMFTT DMBJNT OVNCFS XJMM CF MFTT UIBO
5IF KPCMFTT DMBJNT SF
QPSU JT JTTVFE BOE BDDPSEJOH UP UIF SFQPSU UIFSF XFSF
OFX VOFN
QMPZNFOU DMBJNT :PV XFSF DPSSFDU JO BTTVNJOH UIBU UIF KPCMFTT DMBJNT
XPVME CF MFTT UIBO
BOE UIFSFGPSF ZPVS CJOBSZ PQUJPO FYQJSFT GPS
a profit.
:PV BSF BCMF UP USBEF CJOBSZ PQUJPOT PO UIF GPMMPXJOH FDPOPNJD EBUB
releases:

t Federal funds rate. 6 4 CBOLT BSF PCMJHBUFE UP NBJOUBJO DFSUBJO MFWFMT
of reserve funds at all times. These reserves are either held with the
'FEFSBM 3FTFSWF #BOL UIF DFOUSBM CBOL GPS UIF 6OJUFE 4UBUFT
PS JO
DBTI MPDBUFE JO UIFJS WBVMUT 4PNFUJNFT XIFO B CBOL JTTVFT B MPBO JU
EFQMFUFT QBSU PG UIJT SFRVJSFE SFTFSWF 8IFO UIJT PDDVST UIF CBOL NVTU
CPSSPX GVOET GSPN BOPUIFS CBOL XJUI B TVSQMVT 5IF GFEFSBM GVOET SBUF
JT UIF JOUFSFTU SBUF BU XIJDI UIFTF CBOLT MFOE GVOET UP FBDI PUIFS 5IF
federal funds target rate is determined by a meeting of the members of
UIF 'FEFSBM 0QFO .BSLFU $PNNJUUFF
UIF DPNNJUUFF JO DIBSHF PG UIF
6 4 HPWFSONFOU T NPOFZ TVQQMZ BOE JOUFSFTU SBUFT 5IF GFEFSBM GVOET
rate is released once a month.

t Jobless claims 5IJT JT B SFQPSU UIBU JT JTTVFE CZ UIF 6 4 %FQBSUNFOU
PG -BCPS PO 5IVSTEBZ PG FBDI XFFL 5IF KPCMFTT DMBJNT SFQPSU USBDLT
how many individuals have filed for new unemployment benefits dur
JOH UIF QBTU XFFL +PCMFTT DMBJNT BSF BO JNQPSUBOU XBZ UP HBVHF UIF
6 4 KPC NBSLFU .PSF QFPQMF åMJOH GPS VOFNQMPZNFOU JT BO JOEJDBUJPO
UIBU UIFSF BSF GFXFS KPCT 'FXFS QFPQMF åMJOH GPS VOFNQMPZNFOU JT BO
JOEJDBUJPO UIBU UIFSF BSF NPSF KPCT

t Nonfarm payrolls. 5IJT JT B SFQPSU JTTVFE CZ UIF 6 4 #VSFBV PG -BCPS
Statistics on the first Friday of each month. This report was created to
EFTDSJCF UIF UPUBM OVNCFS PG 6 4 FNQMPZFFT
FYDMVEJOH HPWFSONFOU
employees, nonprofit employees, and farm employees. This report also
FTUJNBUFT UIF BWFSBHF XFFLMZ FBSOJOHT PG BMM FNQMPZFFT
FYDMVEJOH
UIPTF PVUMJOFE BCPWF 5IJT SFQPSU FTTFOUJBMMZ MPPLT BU XIFUIFS CVTJ
nesses are hiring people or not.

10 BINARY OPTIONS

:PV DBO HFU B CSFBLEPXO PG BMM VQDPNJOH SFMFBTFT XJUI BMM EFUBJMT PO
our companion site, www.traderschoiceoptions.net.

BINARY OPTIONS VS. CBOE (VANILLA)
PUT/CALL OPTIONS

Traditional options are derivative instruments that are exchange traded. An
option gives the owner the right to buy or sell the underlying instrument at
a particular price. Options are traded on various instruments such as indi
WJEVBM TUPDLT
GVUVSFT
DVSSFODJFT
BOE JOEFYFT

There are two basic types of options: a call option and a put option.
8IFO ZPV CVZ PS TFMM BO PQUJPO
ZPV FOUFS JOUP B DPOUSBDU UIBU IBT BO FYQJ
SBUJPO EBUF +VTU MJLF XJUI CJOBSZ PQUJPOT
USBEFST DBO CVZ BOE TFMM UIFN BOZ
time before expiration.

)FSF JT IPX UIF UXP UZQFT PG DPOUSBDUT XPSL

t Call option. A call option gives the owner the right to purchase the un
EFSMZJOH JOTUSVNFOU BU B QBSUJDVMBS QSJDF LOPXO BT UIF TUSJLF QSJDF
BOZ
time before expiration. As an options trader you would buy a call option
JG ZPV UIJOL UIF QSJDF PG UIF VOEFSMZJOH JOTUSVNFOU XJMM HP VQ *G UIF VO
derlying instrument goes up in price, then the owner can purchase the
JOTUSVNFOU BU UIF MPXFS TUSJLF QSJDF BOE TFMM JU PO UIF PQFO NBSLFU UP MPDL
in a profit. If the underlying instrument does not go up in price above the
PQUJPOT TUSJLF QSJDF
UIFO UIF PQUJPO XJMM FYQJSF XPSUIMFTT
&YIJCJU EFQJDUT UIF QSPåU BOE MPTT PG B MPOH WBOJMMB DBMM USBEF
5IF YĄBYJT SFQSFTFOUT UIF QSJDF PG UIF VOEFSMZJOH BU FYQJSBUJPO 5IF
ZĄBYJT SFQSFTFOUT QSPåU BOE MPTT
If you believe that the underlying instrument will not reach a
DFSUBJO TUSJLF QSJDF
ZPV DBO TFMM B DBMM PQUJPO 8IFO ZPV EP UIJT ZPV
receive the options premium, but in return you have an obligation
to sell the underlying at a particular price. If the underlying stays
below the price, no one will want to buy the underlying from you
BU UIF TUSJLF QSJDF BOE ZPV XJMM TJNQMZ HFU UP LFFQ UIF QSFNJVN ZPV
DPMMFDUFE )PXFWFS
JG UIF VOEFSMZJOH JOTUSVNFOU HPFT VQ JO QSJDF
BCPWF UIF TUSJLF QSJDF
ZPV XJMM CF PCMJHBUFE UP TFMM JU UP UIF PXOFS
PG UIF PQUJPO BU UIF MPXFS TUSJLF QSJDF 5IFSFGPSF
ZPV XJMM JODVS
UIF MPTT PG UIF EJGGFSFODF CFUXFFO UIF NBSLFU QSJDF PG UIF VOEFSMZJOH
BOE UIF TUSJLF QSJDF PG UIF DBMM PQUJPO

t Put option. A put option gives the owner the right to sell the underly
JOH JOTUSVNFOU BU BO BHSFFEĄVQPO QSJDF UIF PQUJPO T TUSJLF QSJDF
BOZ

What Are Binary Options? 11
Profit

Strike Price Price at
Expiration

Maximum Risk = Premium

Loss Loss = Premium (if price <= strike price upon expiration)

EXHIBIT 1.2 P&L Graph of a Long Call

time before expiration. As an options trader you buy a put option if
ZPV UIJOL UIF QSJDF PG UIF VOEFSMZJOH JOTUSVNFOU XJMM HP EPXO *G UIF
VOEFSMZJOH JOTUSVNFOU HPFT EPXO JO QSJDF CFMPX UIF TUSJLF QSJDF
ZPV
DPVME CVZ UIF JOTUSVNFOU BU NBSLFU WBMVF BOE TFMM JU BU UIF TUSJLF QSJDF

UIVT MPDLJOH JO ZPVS QSPåU

&YIJCJU EFQJDUT UIF QSPåU BOE MPTT PO B MPOH WBOJMMB QVU USBEF
5IF YĄBYJT SFQSFTFOUT UIF QSJDF PG UIF VOEFSMZJOH BU FYQJSBUJPO 5IF
ZĄBYJT SFQSFTFOUT QSPåU BOE MPTT

If you believe that the underlying instrument will not drop below
UIF TUSJLF QSJDF
UIFO ZPV DBO TFMM B QVU PQUJPO 8IFO ZPV TFMM UIF QVU
option you will collect the price of the option. In return you now have
UIF PCMJHBUJPO UP CVZ UIF VOEFSMZJOH BU UIF TUSJLF QSJDF *G UIF VOEFSMZJOH
TUBZT BCPWF UIF TUSJLF QSJDF
ZPV TJNQMZ DPMMFDU UIF QSFNJVN )PXFWFS

JG UIF VOEFSMZJOH ESPQT CFMPX UIF TUSJLF QSJDF
ZPV XJMM IBWF UP CVZ UIF
VOEFSMZJOH BU B QSJDF UIBU JT IJHIFS UIBO JUT NBSLFU QSJDF
UIVT JODVSSJOH
B MPTT PG UIF EJGGFSFODF CFUXFFO UIF TUSJLF QSJDF BOE UIF NBSLFU QSJDF

Most options are not exercised at the expiration date and are simply
bought and sold prior to expiration. Options on indexes are never exer
DJTFE UIFZ BSF TJNQMZ TFUUMFE JO DBTI 0QUJPO USBEJOH JT B [FSPĄTVN HBNF

meaning for every winner there is a loser. By trading regular options, trad
FST DBO DSFBUF B QMFUIPSB PG TUSBUFHJFT UP TVJU UIFJS TUZMF BOE SFRVJSFNFOUT
There are, however, some issues associated with trading regular options.

0OF LFZ JTTVF JT UIBU XIFO ZPV TFMM UIF PQUJPO ZPV IBWF UP QVU VQ NBS
HJO BOE ZPV UIFPSFUJDBMMZ IBWF VOMJNJUFE SJTL 5IJT XBZ ZPV DBO MPTF NPSF

12 BINARY OPTIONS
Profit
Maximum Risk = Premium
Loss = Premium (if price >= strike price upon expiration)

Strike Price

Price at
Expiration

Loss

EXHIBIT 1.3 P&L Graph of a Long Put

than you put in. For example, let’s assume that you sell a put option on a
QBSUJDVMBS TUPDL BOE UIF TUPDL ESPQT TJHOJåDBOUMZ JO B TIPSU QFSJPE PG UJNF
"T B TFMMFS PG B QVU PQUJPO
ZPV BSF PCMJHBUFE UP CVZ UIJT TUPDL BU UIF TUSJLF
QSJDF 4JODF UIF TUPDL ESPQQFE TJHOJåDBOUMZ
ZPV NBZ FOE VQ UBLJOH B IVHF
loss on your trade in a very short amount of time. This is because your
USBEF XBT OPU DPMMBUFSBMJ[FE CVU UBLFO PO NBSHJO BOE UIF QFSDFOU MPTTFT
can be enormous.

5IF FYDIBOHF BOE PQUJPO DMFBSJOHIPVTFT UBLF UIJT JOUP DPOTJEFSBUJPO
BOE SFRVJSF UIBU USBEFST QVU VQ B MPU PG NPOFZ BT NBSHJO XIFO TFMMJOH PQ
tions and have a certain level of experience since the use of margin can
NBLF UIJT UZQF PG USBEJOH WFSZ SJTLZ 5IFSFGPSF
JU T OPU BMXBZT FBTZ UP GVMMZ
UBLF BEWBOUBHF PG BMM UIF GFBUVSFT UIBU QVU BOE DBMM PQUJPOT DBO QSPWJEF

+VTU MJLF USBEJUJPOBM QVU DBMM PQUJPOT
CJOBSZ PQUJPOT IBWF BO VOEFSMZJOH
BTTFU
UIBU JT
TUPDL JOEFYFT
GPSFJHO DVSSFODZ
BOE GVUVSFT #JOBSZ PQUJPOT
BMTP IBWF B TUSJLF QSJDF BOE BO FYQJSBUJPO UJNF +VTU MJLF USBEJUJPOBM JOEFY
options, binary options cannot be exercised; they are all cash settled at ex
piration. Binaries can be traded in and out of at any time before expiration.

#JOBSJFT BSF TJNJMBS UP USBEJUJPOBM PQUJPOT CVU XJUI TJY LFZ EJGGFSFODFT

1. They have a fixed risk and fixed reward. This means your maximum
SJTL BOE SFXBSE BSF BMXBZT LOPXO BOE DBQQFE *G ZPV IPME B CJOBSZ PQ
UJPO VOUJM FYQJSBUJPO
ZPV XJMM FJUIFS HFU BOE MPTF ZPVS FOUJSF JOWFTU
NFOU PS HFU QFS DPOUSBDU 6OMJLF WBOJMMB QVU DBMM PQUJPOT
UIFSF JT
OPUIJOH JO CFUXFFO )PXFWFS
QMFBTF LFFQ JO NJOE UIBU ZPV NBZ BMXBZT
trade in and out of binary options contracts.

What Are Binary Options? 13

2. Binary options have no puts or calls. They simply have price condi
UJPOT GPS UIF VOEFSMZJOH 5IJT XJMM CF DPWFSFE JO HSFBUFS EFUBJM JO UIF
TVCTFRVFOU TFDUJPOT PG UIJT UFYU


3. Binary options are fully collateralized so that you can never lose
more than you put into a trade. 8JUI CJOBSZ PQUJPOT ZPV DBO JNQMF
ment directional and volatility trades and spreads without any debit
CBMBODF PS NBSHJO DBMM SJTL

4. Low collateral requirement. 8JUI CJOBSZ PQUJPOT ZPV DBO HFU JOUP MPOH
BOE TIPSU USBEFT XJUI NJOJNBM DPMMBUFSBM UIVT
ZPV DBO DVTUPNJ[F ZPVS
USBEJOH TUSBUFHJFT XJUIPVU IBWJOH UP QVU VQ MBSHF NBSHJO SFRVJSFNFOUT

5. Unique behavior as expiration approaches. Since binary options can
CF QSJDFE POMZ BU PS BU FYQJSBUJPO
UIFJS QSFNJVNT CFIBWF DPN
pletely differently from traditional put/call options as expiration ap
QSPBDIFT 5IJT QIFOPNFOPO BOE XBZT UP UBLF BEWBOUBHF PG JU XJMM CF
EJTDVTTFE JO HSFBUFS EFUBJM MBUFS PO JO UIJT UFYU


6. Expiration times. Traditional put/call options usually have monthly and
XFFLMZ FYQJSBUJPOT #JOBSZ PQUJPOT IBWF XFFLMZ
EBJMZ
BOE JOUSBEBZ FY
piration times, which provide for different trading opportunities.

ADVANTAGES/DISADVANTAGES OF BINARY OPTIONS

5IF NBJO BEWBOUBHF PG USBEJOH CJOBSZ PQUJPOT JT UIFJS åYFE SJTL BOE åYFE
SFXBSE 8IFO ZPV FOUFS B CJOBSZ PQUJPOT USBEF ZPV LOPX ZPVS NBYJNVN
QSPåU BOE NBYJNVN MPTT VQ GSPOU 8JUI B CJOBSZ PQUJPOT DPOUSBDU ZPV DBO
OFWFS MPTF NPSF UIBO PO BOZ POF DPOUSBDU 0O UIF PUIFS TJEF PG UIF
DPJO
ZPV DBO OFWFS XJO NPSF UIBO PO BOZ DPOUSBDU

#JOBSZ PQUJPOT IBWF SFMBUJWFMZ TNBMM DPOUSBDU TJ[FT
XIJDI BSF BMXBZT
CBTFE PO 5IFZ BSF BWBJMBCMF PO NVMUJQMF JOTUSVNFOUT BOE SFRVJSF MFTT
initial investment than traditional options. This way you can trade com
NPEJUJFT NBSLFUT BOE FDPOPNJD FWFOUT BMM GSPN B TJNQMF POMJOF QMBUGPSN
with a low deposit.

Once you understand the concept of binary options, you should find
them fairly easy to trade since you are simply speculating on a particular
PVUDPNF UP PDDVS PS OPU PDDVS CZ B QBSUJDVMBS UJNF XJUI B åYFE SJTL BOE B
fixed payout.

There are also several disadvantages associated with trading binary
PQUJPOT 5IF PCWJPVT POF JT MJNJUFE VQTJEF "MTP
UIF NBSLFU JT OPU ZFU BT
CJH BT XJUI WBOJMMB PQUJPOT
TP TPNFUJNFT UIFSF BSF OPU BT NBOZ TUSJLF QSJD
es, expiration times, or contracts available with binaries.

&YIJCJU EFUBJMT UIF BEWBOUBHFT BOE EJTBEWBOUBHFT PG CJOBSZ PQUJPOT

14 BINARY OPTIONS

EXHIBIT 1.4 Advantages and Disadvantages of Binary Options

Advantages Disadvantages

Fixed risk Fixed reward—maximum potential return of
$100 per contract
Small contract sizes Market not as large as traditional options
market
Easily available on multiple Potentially fewer strike prices available
instruments
More expiration times available

REASONS TO TRADE BINARY OPTIONS

5IFSF BSF B GFX LFZ SFBTPOT ZPV NBZ XBOU UP USBEF CJOBSZ PQUJPOT

t Simple. &BTZĄUPĄVOEFSTUBOE iZFTw iOPw QSPQPTJUJPOT
t Intuitive pricing. At any point the price of a binary is simply the mar

LFU T QFSDFQUJPO PG UIF QFSDFOUBHF MJLFMJIPPE PG UIF DPOUSBDU T TFUUMJOH
BT B iZFT w 5IJT XPSLT PVU OBUVSBMMZ CBTFE PO UIF XBZ CJOBSZ PQUJPOT
are priced, and it will be covered in much greater detail later in this
text.
t Very small contract size. "U FYQJSBUJPO FBDI MPU TFUUMFT BU GPS B
iZFTw PS GPS B iOP w 5IF NBYJNVN DPMMBUFSBM SFRVJSFE JT BMXBZT MFTT
UIBO QFS DPOUSBDU
PGUFO NVDI MFTT :PV DBO OFWFS MPTF NPSF UIBO
your collateral.
t Strictly limited risk. At no point can the contracts be priced outside
UIF SBOHF UP
SFHBSEMFTT PG UIF WPMBUJMJUZ JO UIF VOEFSMZJOH NBS
LFU :PV BMXBZT LOPX ZPVS BCTPMVUF XPSTUĄDBTF SJTL GPS BOZ QPTJUJPO
ZPV UBLF
SFHBSEMFTT PG XIFUIFS ZPV BSF HPJOH MPOH PS TIPSU UIF DPO
tract.
t Multiple markets. 8JUI CJOBSZ PQUJPOT ZPV DBO TQFDVMBUF PO B XJEF
SBOHF PG NBSLFUT BOE BTTFU DMBTTFT BMM GSPN BO POMJOF QMBUGPSN XJUI
a low minimum deposit. Additionally, you can actually use binary op
tions to speculate on the outcome of various economic data releases,
which would normally be fairly difficult for a retail trader without the
use of binary options.
t Option’s price behavior at expiration. Due to their binary nature, the
behavior of a binary option as it approaches expiration greatly differs
from any other trading instrument. If used properly, this behavior may
be exploited for some very interesting trading strategies.
t Binary options markets are open right up until the moment of
expiration. This allows you to place orders to enter and exit a given

What Are Binary Options? 15

CJOBSZ QPTJUJPO NVMUJQMF UJNFT BT UIF NBSLFU NPWFT &WFO UIPVHI UIF
DPOUSBDUT IBWF BO iBMMĄPSĄOPUIJOHw QBZPVU
ZPV BSF OPU SFTUSJDUFE UP BO
iBMMĄPSĄOPUIJOHw USBEJOH TUSBUFHZ TJODF ZPV DBO USBEF JO BOE PVU PG ZPVS
contract at any time before expiration.

5 P TVN JU VQ
XJUI CJOBSZ PQUJPOT ZPV DBO FBTJMZ USBEF WPMBUJMJUZ BT
PQQPTFE UP KVTU EJSFDUJPO
PO NVMUJQMF JOTUSVNFOUT XJUI MJNJUFE SJTL BOE B
relatively low investment.

KEY POINTS: PART 1

To take a quiz on this section, simply visit our companion education site,
www.traderschoiceoptions.net.

t Binary options, also known as digital options or all‐or‐nothing options, are a
type of options derivative that can be considered a yes‐or‐no proposition—
the event either happens or it does not.

t They have a fixed risk and fixed reward. The most you can lose on each
contract is your collateral, and the most you can win is $100.

t You can never lose more than you put into a binary option trade.
t You can use binary options to trade both volatility and direction.
t Binary options have daily, weekly, and hourly expirations.
t Binary options have certain unique characteristics that are unavailable with

CBOE vanilla put/call options.
t Binary options are available to trade on the following underlying

instruments:
t Stock index futures
t Commodities futures
t Spot currency
t Economic data releases
t There are several advantages to trading binary options:
t Simple
t Intuitive pricing
t Small contract size
t Strictly limited risk
t Trade multiple markets
t Unique price behavior at expiration
t Market open right up until the moment of expiration

Binary Options: Strategies for Directional and Volatility Trading. Alex Nekritin.
© 2013 Alex Nekritin. Published 2013 by John Wiley & Sons, Inc.

PART II

Binary Options
Theory

T his section will provide you with a basic understanding of how binary
option trades work.
What You Will Learn:
t 8IBU JT UIF UIFPSZ CFIJOE CJOBSZ PQUJPOT
t 8IBU BSF UIF DPNQPOFOUT PG B CJOBSZ PQUJPO
t ) PX EP CJOBSZ PQUJPO TUSJLF QSJDFT XPSL
t 8 IFO EP CJOBSZ PQUJPOT FYQJSF
t ) PX EP ZPV UBLF B MPOH CJOBSZ PQUJPO
t )PX EP ZPV UBLF B TIPSU CJOBSZ PQUJPO
t )PX BSF CJOBSZ PQUJPOT QSJDFE
t ) PX EP ZPV SFBE B CJOBSZ PQUJPO DIBJO

8IFO ZPV DPNQMFUF UIJT TFDUJPO ZPV TIPVME DMFBSMZ VOEFSTUBOE UIF
logic behind binary option trades.

17

Binary Options: Strategies for Directional and Volatility Trading. Alex Nekritin.
© 2013 Alex Nekritin. Published 2013 by John Wiley & Sons, Inc.

CHAPTER 2

What Does
Binary Mean?

B inary options are considered binary because there are only two po-
UFOUJBM PVUDPNFT BU FYQJSBUJPO PS "U FYQJSBUJPO
UIF DPOEJUJPO
ZPV BSF TQFDVMBUJOH PO DBO CF TJNQMZ true or false 'PS FYBNQMF
JG
ZPV BSF USBEJOH CJOBSZ PQUJPOT PO UIF 4UBOEBSE 1PPS T 4 1
GVUVSFT
UIF
price of the underlying will either be trading above the strike price (true)
PS CFMPX UIF TUSJLF QSJDF GBMTF
BU FYQJSBUJPO #JOBSZ PQUJPOT XJMM BMXBZT
TFUUMF BU JG GBMTF BOE JG USVF

" T B CJOBSZ PQUJPOT USBEFS ZPV DBO QSPå U GSPN FJUIFS B USVF PS GBMTF
TDFOBSJP 5IJT JT CFDBVTF ZPV DBO CVZ PS TFMM UIF CJOBSZ PQUJPO DPOUSBDU

EFQFOEJOH PO XIFSF ZPV GFFM UIF VOEFSMZJOH JOTUSVNFOU JT IFBEJOH :PV
DBO BMTP VTF CJOBSZ PQUJPOT UP QSPå U GSPN WPMBUJMJUZ 5IJT NFBOT UIBU ZPV
DBO VTF CJOBSZ PQUJPOT UP GPSFDBTU NBSLFU SBOHFT BOE CSFBLPVUT XJUIPVU
having to predict direction.

' PS FYBNQMF
JG ZPV TFF B TUSPOH TVQQPSU MFWFM PO B DFSUBJO VOEFSMZJOH
JOTUSVNFOU
ZPV DBO VTF CJOBSZ PQUJPOT UP TQFDVMBUF PO UIF VOEFSMZJOH T n ot
going below that level. Notice how you do not have to forecast where the un-
EFSMZJOH XJMM HP :PV BSF TJNQMZ GPSFDBTUJOH XIFSF JU XJMM OPU HP 6OMJLF XJUI
NBOZ PUIFS JOTUSVNFOUT
ZPV DBO EP UIJT XJUI B SFMBUJWFMZ MPX EFQPTJU BNPVOU

COMPONENTS TO A BINARY OPTION

5IFSF BSF UISFF NBJO DPNQPOFOUT UP B CJOBSZ PQUJPO 5IJT TFDUJPO DPWFST
UIFTF DPNQPOFOUT JO HSFBU EFUBJM

19

20 BINARY OPTIONS

5IF LFZ DPNQPOFOUT BSF

t 4USJLF QSJDF
t &YQJSBUJPO
t 1SFNJVN 1SJDF

Strike Price

8IFO USBEJOH CJOBSZ PQUJPOT
B TUSJLF QSJDF JT TJNQMZ B QSJDF DPOEJUJPO UIBU
ZPV BSF TQFDVMBUJOH PO 8JUI CJOBSZ PQUJPOT ZPV BSF TQFDVMBUJOH JG UIJT DPO-
EJUJPO JT HPJOH UP CF USVF PS GBMTF XIFO UIF PQUJPO FYQJSFT &BDI VOEFSMZJOH
JOTUSVNFOU IBT NVMUJQMF QSJDF DPOEJUJPOT UIBU ZPV DBO TQFDVMBUF PO &BDI
DPOEJUJPO JT OPUBUFE BT GPMMPXT iVOEFSMZJOH OBNF TUSJLF QSJDF FYQJSBUJPO
EBUF UJNF w

'PS FYBNQMF
BO PQUJPO GPS TQFDVMBUJOH PO UIF QSJDF DPOEJUJPO PG
XIFUIFS UIF 4 1 GVUVSFT XJMM CF BCPWF PS CFMPX CZ P.M. would
MPPL BT GPMMPXT i64 NBSDI
QN w 5ISPVHIPVU UIF UFYU

TUSJLF QSJDFT NBZ CF SFGFSSFE UP XJUI B TIPSUIBOE i w PS TJNQMZ

*G ZPV CFMJFWF UIBU UIF 4 1 GVUVSFT XJMM CF BCPWF BU P.M.
ZPV
XPVME CVZ UIF i w TUSJLF QSJDF PQUJPO *G UIF 4 1 GVUVSFT FOE VQ BCPWF
UIF TUSJLF QSJDF
ZPV XJO
BOE JG UIFZ FOE VQ CFMPX
ZPV MPTF

*G ZPV CFMJFWF UIBU UIF GVUVSFT XJMM CF CFMPX BU P.M
ZPV
XPVME TFMM UIF i w PQUJPO *G UIF 4 1 GVUVSFT FOE VQ CFMPX UIF TUSJLF
QSJDF
ZPV XJO JG UIFZ FOE VQ BCPWF UIF TUSJLF QSJDF
ZPV MPTF

&BDI VOEFSMZJOH JOTUSVNFOU IBT NVMUJQMF TUSJLF QSJDFT UIBU ZPV DBO
TQFDVMBUF PO "MM PG UIF TUSJLF QSJDFT UIBU USBEFST DBO TQFDVMBUF PO BSF BWBJM-
able on what is known as an option chain.

&YIJCJU JT BO FYBNQMF PG BO PQUJPO DIBJO GPS 64 CJOBSZ PQUJPOT
5IF åSTU DPMVNO EJTQMBZT BMM PG UIF BWBJMBCMF 64 CJOBSZ PQUJPO TUSJLF
QSJDFT 5IF TFDPOE DPMVNO EJTQMBZT UIF FYQJSBUJPO EBUF BOE UJNF PG FBDI
CJOBSZ PQUJPO DPOUSBDU 5IF UIJSE DPMVNO EJTQMBZT UIF DVSSFOU CJE QSJDF UP
sell) and ask (price to buy).

5ZQJDBMMZ
UIFSF XJMM CF TUSJLF QSJDFT BWBJMBCMF BU UJNFT UIF BWFSBHF
SBOHF GPS BO VOEFSMZJOH JOTUSVNFOU
CPUI BCPWF BOE CFMPX JUT NBSLFU QSJDF
'PS FYBNQMF
JG UIF 4 1 GVUVSFT IBWF BO BWFSBHF EBJMZ SBOHF PG QPJOUT
BOE UIFZ BSF USBEJOH BU
UIFO UIFSF XJMM CF TUSJLF QSJDFT BWBJMBCMF GPS
QPJOUT‰ BCPWF BOE CFMPX %BJMZ TUSJLF QSJDFT XJMM VTVBMMZ CF BWBJMBCMF
JO JODSFNFOUT PG
BOE XFFLMZ PQUJPO TUSJLF QSJDFT XJMM IBWF MBSHFS JODSF-
NFOUT 'PS UIJT TQFDJåD FYBNQMF
ZPV TIPVME TFF TUSJLF QSJDFT VQ UP
BOE EPXO UP GPS UIF EBJMZ PQUJPOT

'PS XFFLMZ PQUJPOT ZPV XJMM TFF TUSJLF QSJDFT BU UJNFT UIF BWFSBHF
XFFLMZ SBOHF .PTU VOEFSMZJOH JOTUSVNFOUT NPWF JO B XJEFS SBOHF EVSJOH
B XFFL UIBO UIFZ EP EVSJOH B EBZ 5IFSFGPSF
ZPV TIPVME TFF NPSF TUSJLF
prices available for weekly options than you would for daily options. For

What Does Binary Mean? 21

Contract 1 Expi Bid Size Bid 3 Offer Size
02-D 2
US 500 (Dec) >1248.5 02-DEC-11 500 35.00 59.50 500
US 500 (Dec) >1236.5 02-DEC-11 500 55.50 77.00 500
US 500 (Dec) >1224.5 02-DEC-11 500 73.00 88.50 500
US 500 (Dec) >1212.5 02-DEC-11 500 85.00 95.50 500
US 500 (Dec) >1200.5 02-DEC-11 500 92.00 99.00 500
US 500 (Dec) >1188.5 02-DEC-11 50 95.50 50
US 500 (Dec) >1176.5 02-DEC-11 50 97.00 -
US 500 (Dec) >1164.5 02-DEC-11 50 97.00 - -
US 500 (Dec) >1152.5 02-DEC-11 50 97.00 - -
US 500 (Dec) >1140.5 02-DEC-11 50 97.00 - -
US 500 (Dec) >1128.5 02-DEC-11 50 97.00 - -
US 500 (Dec) >1116.5 02-DEC-11 50 97.00 - -
US 500 (Dec) >1104.5 50 97.00 - -
-

EXHIBIT 2.1 Option Chain

FYBNQMF
PO B XFFLMZ PQUJPO DIBJO GPS 4 1 GVUVSFT XJUI B NBSLFU QSJDF PG

ZPV NBZ TFF PQUJPOT BMM UIF XBZ VQ UP BOE EPXO UP
XIJMF
PO B EBJMZ PQUJPO DIBJO GPS UIF TBNF VOEFSMZJOH JOTUSVNFOU XJUI UIF TBNF
NBSLFU QSJDF
ZPV NBZ POMZ TFF TUSJLF QSJDFT GSPN UP

There are traders trading each of the strike prices for a particular un-
EFSMZJOH JOTUSVNFOU 0QUJPO QSFNJVNT DIBOHF BT UJNF QBTTFT
BT EPFT UIF
QSJDF PG UIF VOEFSMZJOH NPWFT +VTU MJLF WBOJMMB QVU DBMM PQUJPOT
CJOBSZ PQ-
UJPOT DBO CF JOĄUIFĄNPOFZ
BUĄUIFĄNPOFZ
BOE PVUĄPGĄUIFĄNPOFZ 4JODF UIFSF
BSF OP QVUT
UIFTF EFåOJUJPOT DIBOHF
EFQFOEJOH PO XIFUIFS ZPV BSF UBLJOH
a long or short position.

Expiration

"T ZPV XJMM TIPSUMZ MFBSO
XIFO USBEJOH CJOBSZ PQUJPOT DPOUSBDUT ZPV BSF
speculating for a certain price condition to be true or false by a certain
FYQJSBUJPO UJNF 'PS FYBNQMF
JG 4 1 GVUVSFT BSF USBEJOH BU XIFO ZPV
FOUFS ZPVS USBEF
ZPV DBO TQFDVMBUF UIBU UIF QSJDF PG 4 1 GVUVSFT XJMM PS XJMM
OPU CF BCPWF CZ UIF FOE PG UIF EBZ

8JUI CJOBSZ PQUJPOT ZPV BSF BCMF UP USBEF DPOUSBDUT CBTFE PO TFWFSBM
FYQJSBUJPO NPEFMT

t Intraday. 8JUI JOUSBEBZ CJOBSJFT ZPV BSF BCMF UP DIPPTF TFWFSBM CJOBSZ
PQUJPOT DPOUSBDUT UIBU FYQJSF UISPVHIPVU UIF EBZ 8JUI JOUSBEBZ CJOBSZ
PQUJPOT ZPV DBO DIPPTF GSPN CJOBSJFT UIBU FYQJSF BU A.M
P.M

P.M
BOE P.M &45 5IFTF PQUJPOT FYQJSF XJUIJO B USBEJOH EBZ

t Daily. %BJMZ CJOBSZ PQUJPOT FYQJSF EBJMZ BU P.M &45 .POEBZ
through Friday.

t Weekly. 8FFLMZ CJOBSZ PQUJPOT FYQJSF FWFSZ 'SJEBZ BU EJGGFSFOU UJNFT

depending on the underlying asset.

22 BINARY OPTIONS

%JGGFSFOU FYQJSBUJPO UJNFT HJWF ZPV UIF PQQPSUVOJUZ UP USBEF PO QSJDF
NPWFNFOUT PWFS EJGGFSFOU UJNF GSBNFT
GSPN UIF WFSZ TIPSU UFSN UP POF
XFFL JO UIF GVUVSF +VTU MJLF XJUI WBOJMMB QVU DBMM PQUJPOT
UIF GVSUIFS BXBZ
UIF FYQJSBUJPO EBUF
UIF NPSF UJNF WBMVF BO PQUJPOT DPOUSBDU XJMM IBWF
1MFBTF LFFQ JO NJOE UIBU ZPV DBO USBEF JO BOE PVU PG BOZ CJOBSZ PQUJPOT
DPOUSBDU BU BOZ UJNF VQ VOUJM FYQJSBUJPO

LONG TRADING

Long In‐the‐Money

" CJOBSZ PQUJPO JT DPOTJEFSFE JOĄUIFĄNPOFZ PO B MPOH USBEF JG UIF TUSJLF
QSJDF JT CFMPX UIF DVSSFOU NBSLFU QSJDF 'PS FYBNQMF
JG UIF 4 1 GVUVSFT
XFSF USBEJOH BU
BO PQUJPO XPVME CF DPOTJEFSFE JOĄUIFĄNPOFZ

8IFO CVZJOH BO JOĄUIFĄNPOFZ CJOBSZ PQUJPO ZPV BSF TQFDVMBUJOH UIBU UIF
VOEFSMZJOH XJMM OPU ESPQ CFMPX B DFSUBJO QSJDF *U EPFT OPU NBUUFS UP ZPV
whether it goes up or down as long as it does not drop below the strike price.

*O &YIJCJU
UIF ZĄBYJT SFQSFTFOUT UIF BWBJMBCMF TUSJLF QSJDFT 5IF EBSL
HSFZ EBTIFE MJOF SFQSFTFOUT UIF NBSLFU QSJDF PG UIF VOEFSMZJOH 4 1 GVUVSFT

and the light grey dashed line represents the binary option contract.

Available
Strike Prices

1230

1225 The binary option with a strike price of 1180 is below
1220 the current price of the S&P futures and therefore
1215 is considered “in-the-money” for a long trade.

1210

1205

1200 Market price of S&P futures

1195

1190

1185 Binary option with 1180 strike price
1180

1175

1170

EXHIBIT 2.2 Long In‐the‐Money Binary Option

What Does Binary Mean? 23

Long Out‐of‐the‐Money

" CJOBSZ PQUJPO JT DPOTJEFSFE PVUĄPGĄUIFĄNPOFZ PO B MPOH USBEF JG UIF
TUSJLF QSJDF JT BCPWF UIF DVSSFOU NBSLFU QSJDF 'PS FYBNQMF
JG UIF 4 1
GVUVSFT BSF USBEJOH BU
B PQUJPO XPVME CF DPOTJEFSFE PVUĄPGĄUIFĄ
NPOFZ

8IFO CVZJOH BO PVUĄPGĄUIFĄNPOFZ PQUJPO
ZPV BSF TQFDVMBUJOH UIBU UIF
VOEFSMZJOH XJMM NPWF VQ CZ B DFSUBJO BNPVOU 8IFO CVZJOH BO PVUĄPGĄUIFĄ
NPOFZ PQUJPO
ZPV IBWF CFUUFS QBZPVU PEET UIBO ZPV EP XJUI BO BUĄUIFĄ
NPOFZ PS JOĄUIFĄNPOFZ PQUJPO

*O &YIJCJU
UIF ZĄBYJT SFQSFTFOUT UIF BWBJMBCMF TUSJLF QSJDFT 5IF
EBSL HSFZ EBTIFE MJOF SFQSFTFOUT UIF NBSLFU QSJDF PG UIF VOEFSMZJOH 4 1
GVUVSFT

BOE UIF MJHIU HSFZ EBTIFE MJOF SFQSFTFOUT UIF CJOBSZ PQUJPO
contract.

Available The binary option with a strike price of 1220 is above
Strike Prices the current price of the S&P futures and therefore
is considered “out-of-the-money” for a long trade.
1230

1225

1220 Binary option with 1220 strike price

1215

1210

1205

1200 Market price of S&P futures

1195

1190

1185

1180

1175

1170

EXHIBIT 2.3 Long Out‐of‐the‐Money Binary Option

Long At‐the‐Money

" CJOBSZ PQUJPO JT DPOTJEFSFE BUĄUIFĄNPOFZ XIFO UIF TUSJLF QSJDF BOE
VOEFSMZJOH QSJDF BSF UIF TBNF 8IFO CVZJOH BO BUĄUIFĄNPOFZ PQUJPO

ZPV BSF TJNQMZ TQFDVMBUJOH UIBU UIF VOEFSMZJOH JOTUSVNFOU XJMM HP VQ

24 BINARY OPTIONS

BOE EPO U DBSF CZ IPX NVDI 'PS FYBNQMF
JG UIF NBSLFU QSJDF PG UIF
VOEFSMZJOH JT
UIF QSJDF PG UIF CJOBSZ PQUJPO UIBU ZPV XPVME CVZ JT
BMTP

*O &YIJCJU
UIF ZĄBYJT SFQSFTFOUT UIF BWBJMBCMF TUSJLF QSJDFT 5IF
EBSL HSFZ EBTIFE MJOF SFQSFTFOUT UIF NBSLFU QSJDF PG UIF VOEFSMZJOH
4 1 GVUVSFT

BOE UIF MJHIU HSFZ EBTIFE MJOF SFQSFTFOUT UIF CJOBSZ PQUJPO
contract.

Available
Strike Prices

1230 The binary option with a strike price of 1200 is at
1225 the current price of the S&P futures and therefore
1220
is considered “at-the-money” for a long trade.

1215

1210

1205
Binary option with 1220 strike price

1200 Market price of S&P futures

1195

1190

1185

1180

1175

1170

EXHIBIT 2.4 Long At‐the‐Money Binary Option

SHORT TRADING

Short In‐the‐Money

0O B TIPSU USBEF
B CJOBSZ PQUJPO JT DPOTJEFSFE JOĄUIFĄNPOFZ XIFO UIF
TUSJLF QSJDF JT BCPWF UIF VOEFSMZJOH QSJDF 8IFO TFMMJOH BO JOĄUIFĄNPOFZ
PQUJPO
ZPV BSF TQFDVMBUJOH UIBU UIF VOEFSMZJOH XJMM OPU SFBDI B TUSJLF QSJDF
:PV EPO U DBSF JG JU HPFT VQ PS EPXO BT MPOH BT JU JT OPU BCPWF UIF TUSJLF QSJDF

What Does Binary Mean? 25

BU FYQJSBUJPO 'PS FYBNQMF
JG UIF 4 1 GVUVSFT BSF USBEJOH BU
B
PQUJPO JT DPOTJEFSFE JOĄUIFĄNPOFZ

*O &YIJCJU
UIF ZĄBYJT SFQSFTFOUT UIF BWBJMBCMF TUSJLF QSJDFT 5IF
EBSL HSFZ EBTIFE MJOF SFQSFTFOUT UIF NBSLFU QSJDF PG UIF VOEFSMZJOH
4 1 GVUVSFT

BOE UIF MJHIU HSFZ EBTIFE MJOF SFQSFTFOUT UIF CJOBSZ PQUJPO
contract.

Available The binary option with a strike price of 1210 is above
Strike Prices the current price of the S&P futures and therefore
is considered “in-the-money” for a short trade.
1230

1225

1220

1215

1210 Binary option with 1210 strike price

1205

1200 Market price of S&P futures

1195

1190

1185

1180

1175

1170

EXHIBIT 2.5 Short In‐the‐Money Binary Option

Short Out‐of‐the‐Money

0O B TIPSU USBEF
B CJOBSZ PQUJPO JT DPOTJEFSFE PVUĄPGĄUIF NPOFZ XIFO UIF
TUSJLF QSJDF JT CFMPX UIF QSJDF PG UIF VOEFSMZJOH 8IFO TFMMJOH BO PVUĄPGĄ
UIFĄNPOFZ CJOBSZ PQUJPO
ZPV BSF IPQJOH UIBU UIF VOEFSMZJOH XJMM ESPQ CZ
B DFSUBJO BNPVOU 5IF SFBTPO ZPV XPVME TFMM BO PVUĄPGĄUIFĄNPOFZ PQUJPO

26 BINARY OPTIONS

JOTUFBE PG BO JOĄUIFĄNPOFZ PS BO BUĄUIFĄNPOFZ PQUJPO JT UIBU UIF PVUĄPGĄUIFĄ
NPOFZ PQUJPOT PGGFST IJHIFS QBZPVU PEET

*O &YIJCJU
UIF ZĄBYJT SFQSFTFOUT UIF BWBJMBCMF TUSJLF QSJDFT 5IF
EBSL HSFZ EBTIFE MJOF SFQSFTFOUT UIF NBSLFU QSJDF PG UIF VOEFSMZJOH 4 1
GVUVSFT

BOE UIF MJHIU HSFZ EBTIFE MJOF SFQSFTFOUT UIF CJOBSZ PQUJPO
contract.

Available
Strike Prices

1230 The binary option with a strike price of 1180 is below
1225 the current price of the S&P futures and therefore
1220 is considered “out-of-the-money” for a short trade.

1215

1210

1205

1200 Market price of S&P futures

1195

1190

1185

1180 Binary option with 1180 strike price

1175

1170

EXHIBIT 2.6 Short Out‐of‐the‐Money Binary Option

Short At‐the‐Money

+VTU MJLF XJUI B MPOH USBEF
B CJOBSZ PQUJPO JT DPOTJEFSFE BUĄUIFĄNPOFZ
XIFO UIF TUSJLF QSJDF BOE UIF NBSLFU QSJDF PG UIF VOEFSMZJOH BSF UIF TBNF
5IF SFBTPO ZPV XPVME TFMM BO BUĄUIFĄNPOFZ CJOBSZ PQUJPO JT UIBU ZPV XBOU
UP TQFDVMBUF PO UIF VOEFSMZJOH T TJNQMZ HPJOH EPXO BOE EPO U DBSF CZ IPX
NVDI 'PS FYBNQMF
JG UIF NBSLFU QSJDF PG 4 1 GVUVSFT JT
ZPV XPVME
TFMM UIF PQUJPO

*O &YIJCJU
UIF ZĄBYJT SFQSFTFOUT UIF BWBJMBCMF TUSJLF QSJDFT 5IF
EBSL HSFZ EBTIFE MJOF SFQSFTFOUT UIF NBSLFU QSJDF PG UIF VOEFSMZJOH
4 1 GVUVSFT

BOE UIF MJHIU HSFZ EBTIFE MJOF SFQSFTFOUT UIF CJOBSZ PQUJPO
contract.

What Does Binary Mean? 27

Available
Strike Prices

1230 The binary option with a strike price of 1200 is at
1225 the current price of the S&P futures and therefore

is considered “at-the-money” for a short trade.

1220

1215

1210

1205
Binary option with 1200 strike price

1200 Market price of S&P futures

1195

1190

1185

1180

1175

1170

EXHIBIT 2.7 Short At‐the‐Money Binary Option

Binary Options: Strategies for Directional and Volatility Trading. Alex Nekritin.
© 2013 Alex Nekritin. Published 2013 by John Wiley & Sons, Inc.

CHAPTER 3

Pricing

S ince a binary option can be settled at expiration only at $0 or $100,
the price of the option will fluctuate between $0 and $100 until ex-
piration. The price will fluctuate as a result of market transactions
made by traders.

Just like all markets, the participants will make bids and offers to each
other in order to trade each strike price of the options contract until expi-
ration. There are a number of components that will be taken into consid-
eration by market participants in order to determine the price of a binary
option contract. Two key components are the strike price of the option and
the time remaining until expiration.

STRIKE PRICE
As you learned earlier, the strike price represents a specific price condition
for the underlying instrument. Each instrument will have multiple strike
prices. For example, if the Standard & Poor’s (S&P) futures are trading at
1200, there may be strike prices for 20 points up and 20 points down.

Exhibit 3.1 displays an option chain of the US 500 binary options strike
prices.

Typically, there are strike prices available for two times the average
daily range for each underlying security, both above and below its market
price at any given time the market is open.

29

30 BINARY OPTIONS

Contract Bid Offer
5
Daily US 500 (Mar) > 1221 2.1 5
7.8
Daily US 500 (Mar) > 1218 2.1
12.7
Daily US 500 (Mar) > 1215 4.9 20
29
Daily US 500 (Mar) > 1212 9.7 40.1
51.6
Daily US 500 (Mar) > 1209 17 63.1
73.9
Daily US 500 (Mar) > 1206 26 83.4
90.4
Daily US 500 (Mar) > 1203 36.1 95.3
98.4
Daily US 500 (Mar) > 1200 48.1 99.4

Daily US 500 (Mar) > 1197 60.1
Daily US 500 (Mar) > 1194 71.2
Daily US 500 (Mar) > 1191 79.9
Daily US 500 (Mar) > 1188 87.4
Daily US 500 (Mar) > 1185 92.3
Daily US 500 (Mar) > 1182 95.4
Daily US 500 (Mar) > 1179 96.4

12 hours until expiration, futures trading at 1200

EXHIBIT 3.1 Option Chain

When traders purchase a certain strike price, they want the underly-
ing instrument to be above that strike price at expiration so that they can
receive the $100 settlement. Conversely, when traders sell a certain strike
price, they want the underlying instrument to be below that price at expira-
tion so that they can receive their $100 settlement. This will be explained
in greater detail in the subsequent sections.

TIME VALUE

Time value simply represents the amount of time until expiration. An out‐
of‐the‐money option with more time until expiration has a higher chance of
being settled in‐the‐money for a trader than an option with less time until
expiration. For example, a 10‐point move on the S&P futures is more likely
to happen over one week than in one day.

Exhibit 3.2 depicts how an option’s time value decreases as the con-
tract nears expiration. The y‐axis represents the time value of an option.
The x‐axis represents the amount of time until the option contract expires.

Time value is taken into consideration by traders, as their chances
of winning are higher if they own an option that has more time until ex-
piration. Therefore, they are willing to pay more money for the options

Pricing 31

As an option contract nears expiration,
the option’s time value drops.

Option Time Value

Amount of time until expiration

12 hours until 20 minutes until
expiration expiration

EXHIBIT 3.2 Image Representing an Option’s Time Value

with longer duration. For example, if the S&P futures are trading at
1200, a 1210 weekly option will be more expensive than a 1210 daily
option, which will subsequently be more expensive than a 1210 hourly
option.

Exhibit 3.3 depicts a trader’s willingness to pay more for options with
a longer time until expiration. The longer the time until expiration, the bet-
ter the odds the event will occur, and therefore the option will be priced
higher.

Because you can trade in and out of binary options up until expira-
tion, their time value will change as expiration approaches. This is known
as time decay. As traders deem an option to be unlikely to expire in‐the‐
money, they will want to sell it, which drives its price down toward $0.

Weekly

Daily
Hourly

EXHIBIT 3.3 Image Representing an Option’s Price Relative to Time until Expiration

32 BINARY OPTIONS

EXHIBIT 3.4 Behavior of a Binary Option’s Contract Value as Expiration
Approaches

As Expiration Approaches … Contract Value Is:

Underlying market price is lower than Decreasing to 0
strike price Increasing to 100
Underlying market price is higher than
strike price

However, as traders perceive an option likely to expire in‐the‐money, they
will want to buy it and thus drive its price up toward $100.

To summarize time decay, as expiration approaches, if the underlying
market price remains below the strike price, the contract value will con-
tinuously decrease to 0. If, however, the underlying market price remains
above the strike price, the contract value will increase to 100.

Exhibit 3.4 shows the contract value of a binary option as its expiration
approaches.

PRICE AS A NATURAL MARKET CONSENSUS

Another way of looking at binary options pricing is: The more likely a price
event for an underlying entity is to occur at expiration, the closer the price
of the option is going to be to $100. Conversely, the less likely an event is
to occur, the closer the price will be to $0. Every point on a binary options
contract is worth $1.

The logic behind this is as follows: If a price event is perceived to be
very likely to occur at expiration, then all market participants are going to
want to bet on its happening. Therefore, they will all want to buy the option
that signifies the price event, so price of this option will head toward $100,
which is its maximum value.

Conversely, if a price event is unlikely to occur at expiration, market
participants are not going to want to purchase the option. The participants
that are holding it are going to want to sell it to preserve at least some of
their investment. For this reason, the price of the options is going to head
toward $0.

Using this same logic, if the market participants perceive there to be a
50‐50 chance of an event’s occurring, the option that will signify this event
will be around $50.

Exhibit 3.5 shows how price behaves based on the view of market par-
ticipants. For example, let’s assume that the S&P futures are trading at
1200 with four days until expiration:

Pricing 33

EXHIBIT 3.5 Market Participant View of an Event Occurring and the Effect This
Has on a Binary Option’s Strike Price

Market Participant View of Event Binary Option Price
Occurring

More likely Price increases toward $100

50‐50 chance Price is roughly $50

Less likely Price decreases toward $0

t " TUSJLF QSJDF PG XJUI POF EBZ VOUJM FYQJSBUJPO XPVME CF NPTU
likely worth $0 since it is so highly unlikely that the S&P futures will
jump 100 points before expiration.

t " TUSJLF QSJDF PG XJMM NPTU MJLFMZ CF USBEJOH BU TJODF JU JT
very likely that the S&P futures will not drop below 100 points by
expiration.

t " TUSJLF QSJDF PG XJMM NPTU MJLFMZ CF XPSUI BSPVOE 5IF SFBTPO
for this is that there is roughly a 50‐50 chance that the S&P futures
will end up below or above that strike price since 1200 is the mar-
ket price. Traders have roughly a 50 percent chance of success on
the trade; therefore, they will need at least a 2‐to‐1 payout to enter
it. Since the payout at expiration is $100, the options price will be
roughly $50.

t " TUSJLF QSJDF PG XJMM CF VOEFS TJODF UIFSF JT B MFTT UIBO
percent chance that the S&P futures will end up above 1210 and trad-
ers will need better odds to enter the trade. To get better odds, the
option will need to be priced under $50 since the payout is $100 at
expiration.

Of course, time until expiration plays a critical role here also. If
there is a very short amount of time until expiration and it’s unlikely
that the underlying will reach the strike price, the option price will head
toward $0.

If there is still some time left until expiration and traders believe that
the price may reach 1210 by then, they would be willing to pay something
for the option contract. This amount will be below $50 and depends on the
time until expiration and other factors that may affect the perception of the
market participants.

As you can see, the price of a binary option naturally can be viewed as
the consensus of market participants of where the underlying is going to
go by expiration.

Exhibit 3.6 is an example of what a binary option chain (of the US
500 binary options) may look like 12 hours until expiration.

34 BINARY OPTIONS

Contract Bid Offer
Daily US 500 (Mar) > 1268 2.1 5
Daily US 500 (Mar) > 1265 4.9 7.8
Daily US 500 (Mar) > 1262 9.7 12.7
Daily US 500 (Mar) > 1259 17 20
Daily US 500 (Mar) > 1256 26 29
Daily US 500 (Mar) > 1253 36.1 40.1
Daily US 500 (Mar) > 1250 48.1 51.6
Daily US 500 (Mar) > 1247 60.1 63.1
Daily US 500 (Mar) > 1244 71.2 73.9
Daily US 500 (Mar) > 1241 79.9 83.4
Daily US 500 (Mar) > 1238 87.4 90.4
Daily US 500 (Mar) > 1235 92.3 95.3

Daily US 500 (Mar) > 1232 95.4 98.4

12 hours to expiration, futures trading at 1250

EXHIBIT 3.6 Option Chain with 12 Hours until Expiration

Exhibit 3.7 is an example of what a binary option chain of the US
500 binary options may look like 20 to 30 minutes until expiration.

As market participants make trades on each of the strike prices, the bid
and ask price of the option contracts change.

Contract Bid Offer
3.0
Daily US 500 (Mar) > 1268 - 3.0
7.0
Daily US 500 (Mar) > 1265 - 7.0
7.0
Daily US 500 (Mar) > 1262 - 66.00
60.00
Daily US 500 (Mar) > 1259 - 80.00
-
Daily US 500 (Mar) > 1256 - -
-
Daily US 500 (Mar) > 1253 54.00 -
-
Daily US 500 (Mar) > 1250 56.00

Daily US 500 (Mar) > 1247 70.00

Daily US 500 (Mar) > 1244 97.00

Daily US 500 (Mar) > 1241 97.00

Daily US 500 (Mar) > 1238 97.00

Daily US 500 (Mar) > 1235 97.00

Daily US 500 (Mar) > 1232 97.00

20 minutes to expiration, futures trading at 1250

EXHIBIT 3.7 Option Chain with 20 Minutes until Expiration

Pricing 35

Let’s look at some more examples here:
If the S&P futures are trading at $1280 on Monday and you are looking
to enter trades for binary options that will expire on Friday:

t " PQUJPO JT MJLFMZ UP CF QSJDFE WFSZ DMPTF UP TJODF UIF NBSLFU
participants will find it likely for the S&P futures to stay above $1230 at
expiration.

t " PQUJPO JT MJLFMZ UP CF QSJDFE WFSZ DMPTF UP TJODF NBSLFU QBS-
ticipants will find it unlikely that the S&P futures will move up this
much in such a short period of time.

t " PQUJPO XJMM CF QSJDFE BU BSPVOE TJODF NBSLFU QBSUJDJQBOUT TFF
a roughly 50 percent change for the S&P futures to end up above $1280.

READING A BINARY OPTIONS CHAIN

Just like regular vanilla options, binary options have option chains. These
chains show you all the possible conditions that you can speculate on.
In other words, you can bet on the price of the underlying to be above
or below a wide range of prices. Typically, strike prices are available
roughly two times the average daily range for daily options and two times
the average weekly range for weekly options. To see an actual option chain,
you can download a demo at www.traderschoiceoptions.net.

The higher the probability of a condition to occur by expiration, the
less your payout odds are on your trade. For example, if you are to fore-
cast the underlying’s going up 50 points by expiration, you may have to
put up only $5 to win $100. However, if you speculate for the underlying
simply not to drop by 50 points until expiration, you may have to bet
$95 to win just $5. Of course, in the second example you are much more
likely to win than you are in the first example, which is why the odds
available to you are much lower. Please keep in mind that we are using
arbitrary numbers in these examples. They are not an actual reflection of
what any underlying would be doing, and they are not connected to any
option chain.

Exhibit 3.8 illustrates the payout odds based on the probability of a
move. Exhibit 3.9 is an example of an option chain of the US 500 binary
options strike prices with 12 hours until expiration.

In Exhibit 3.9, the S&P futures (US 500) are trading at around 1225. If
you want to speculate that the US 500 is going to close above 1297.5 by ex-
piration, you can purchase your option at the ask price of $6.5. The price of
the option is relatively cheap since, historically, it is fairly unlikely that the
S&P futures will jump up above the strike price by expiration.

36 BINARY OPTIONS

EXHIBIT 3.8 Table Depicting the Probability of a Condition’s Being True and the
Payout Odds Associated with It

Probability of Type of Trade Payout Odds
Condition to be True

Lower Out‐of‐the‐money Higher
Close to 50‐50 At‐the‐money Example: Put up $15/contract to win
Higher In‐the‐money $85/contract
Close to even
Example: Put up $51/contract to win
$49/contract
Lower
Example: Put up $70/contract to win
$30/contract

Exhibit 3.10 is the profit‐and‐loss (P&L) graph of going long the 1297.5
binary option. The x‐axis depicts the price of the underlying asset, and the
y‐axis depicts profit and loss. The 1297.5 binary option is considered out-
of-the-money. The chances of the S&P futures moving 72 points and closing
above 1297 are very small, and therefore the payout is high.

Since the S&P futures are trading at 1225.5 during the snapshot of the
option chain, the 1225.5 option has an ask price of 55.5 and a bid price of
51. The reason for this is that the strike price and the price of the under-
lying are very close to each other. When this occurs, there is a roughly
50 percent chance that the underlying will go above or below its actual
price by expiration and therefore the binary options price gives you rough-
ly 1‐to‐1 odds, meaning you bet $55.5 to win $44.5 for a reward to risk ratio
of .802:1 (44.5/55.5).

US 500 (Mar) >1321.5 (4:15PM) 16-DEC-11 - - 3.00
US 500 (Mar) >1309.5 (4:15PM) 16-DEC-11 50 1.00 4.50
US 500 (Mar) >1297.5 (4:15PM) 16-DEC-11 500 3.00 6.50
US 500 (Mar) >1285.5 (4:15PM) 16-DEC-11 500 6.50 10.50
US 500 (Mar) >1273.5 (4:15PM) 16-DEC-11 500 12.00 15.50
US 500 (Mar) >1261.5 (4:15PM) 16-DEC-11 500 19.50 23.00
US 500 (Mar) >1249.5 (4:15PM) 16-DEC-11 500 28.50 32.50
US 500 (Mar) >1237.5 (4:15PM) 16-DEC-11 500 39.50 43.50
US 500 (Mar) >1225.5 (4:15PM) 16-DEC-11 500 51.00 55.50
US 500 (Mar) >1213.5 (4:15PM) 16-DEC-11 500 62.00 66.00
US 500 (Mar) >1201.5 (4:15PM) 16-DEC-11 500 71.00 75.00
US 500 (Mar) >1189.5 (4:15PM) 16-DEC-11 500 78.50 82.50
US 500 (Mar) >1177.5 (4:15PM) 16-DEC-11 500 64.00 88.00

EXHIBIT 3.9 Binary Option Chain (To see a live option chain, you can download
a FREE demo at www.traderschoiceoptions.net)

Pricing 37

1297.5
binary option

Profit 100
75

50 Profit = $93.5

25 Collateral = $6.5 Price of
0 Underlying
(S&P Futures)
–25
Market Price The light grey shaded area represents the
–50 (= 1225) required collateral for one contract.

–75 The dark grey shaded area represents the
Loss –100 maximum profit for one contract.

EXHIBIT 3.10 Payout Odds of a Large, Less Likely Move (out‐of‐the‐money)

Exhibit 3.11 is the P&L graph of going long the 1225.5 binary option.
The x‐axis depicts the price of the underlying asset and the y‐axis depicts
profit and loss. There is roughly a 50 percent likelihood of the S&P futures
closing above 1225.5 and therefore the payout reflects this.

If you believe that the underlying will not go down significantly, you
can purchase the 1177.5 strike price for $88. When you make this purchase,

Profit 100 1225.5
75 binary option

50

25 Profit = $44.5 Price of
0 Underlying
(S&P Futures)
–25
Collateral = $55.5
–50
The light grey shaded area represents the
–75 required collateral for one contract.
Loss –100
The dark grey shaded area represents the
maximum profit for one contract.

Market Price
(= 1225.5)

EXHIBIT 3.11 Payout Odds of a Smaller, More Likely Move (at‐the‐money)

38 BINARY OPTIONS

Profit 100

75
1177.5

50 binary option

25 Max Profit = $12 Price of
0 Underlying
(S&P Futures)
–25
Max Loss = $88 The light grey shaded area represents
the required collateral for one contract.
–50 Market Price
(= 1225) The dark grey shaded area represents
–75 the maximum profit for one contract.
Loss –100

EXHIBIT 3.12 Payout Odds of a Larger, Less Likely Move (in‐the‐money)

as long as S&P futures do not drop by 47.5 points to 1177.5, the option will
settle at $100 and you will turn your $88 into $100, meaning you bet $88 to
win $12 for a reward to risk ratio of .136:1 (12/88).

Exhibit 3.12 depicts the profit and loss of going long the US 500 bi-
nary option with a strike price of 1177.5. In this example, the 1177.5 bi-
nary option is in‐the‐money, and the chance of the S&P futures going down
47.5 points is relatively small; therefore, the payout is much less than the
previous examples. The x‐axis depicts the price of the underlying asset and
the y‐axis depicts profit and loss.

KEY POINTS: PART 2

To take a quiz on this section, simply visit our companion education site,
www.traderschoiceoptions.net.

t Binary options are considered binary because there are only two potential
outcomes at expiration: 0 or 100. At expiration, the condition you are
speculating on can be simply either TRUE (100) or FALSE (0).

t There are three main components to a binary option:
t Strike price
t Expiration
t Premium/Price of the binary option

t When trading binary options, a strike price is simply a price condition that
you are speculating on. With binary options you are speculating if this con-
dition is going to be true or false when the option expires.

Pricing 39

t Binary options have several expiration times:

t Intraday: Intraday binary options expire daily at 11 A.M., 12 P.M., 2 P.M.,
and 4:15 P.M. New York time (EST).

t Daily: Daily binary options expire daily at 4:15 P.M. New York time (EST).

t Weekly: Weekly binary options expire every Friday at varying times de-
pending on the underlying asset.

t On a long trade, a binary option is considered in‐the‐money if the strike
price is below the market price of the underlying.

t On a long trade, a binary option is considered out‐of‐the‐money if the
strike price is above the market price of the underlying.

t On a short trade, a binary option is considered in‐the‐money when the
strike price is above the market price of the underlying.

t On a short trade, a binary option is considered out‐of‐the‐money when the
strike price is below the market price of the underlying.

t On either a long or short trade, a binary option is considered at‐the‐money
when the strike price and the market price of the underlying are the same.

t Because a binary option can be settled at expiration only at $0 or $100, the
price of the option will fluctuate between $0 and $100 up until expiration.

t As expiration approaches, if the underlying market price of the binary re-
mains below the strike price, the contract value will continuously decrease
to 0. If, however, the underlying market price remains above the strike
price, the contract value will increase to 100.

t Typically, strike prices are available roughly two times the average daily
range for daily options and two times the average weekly range for weekly
options.

t Binary options chains show you all the possible conditions that you can
speculate on.

t The higher the probability of a condition’s occurring by expiration, the less
your payout odds (return on collateral) are on your trade.