Binary Options Strategies for Directional and Volatility

Entering and Exiting Binary Option Trades 93

In Exhibit 6.20, the y‐axis represents available strike prices. The dark
grey dashed line represents the market price of the S&P futures, and the
light grey dashed line represents the binary option contract. As expiration
approaches, the S&P futures have risen seven points and are currently trad-
ing at 1257.

Available
Strike Prices

1268

1265

1262

1259 Market price of S&P futures
1256
1253 Sell 1 contract of
US 500 > 1256 Binary

1250

1247

1244

1241

1238

1235 Closer to Expiration

1232

EXHIBIT 6.20 Binary Option Condition Closer to Expiration

Summary Exhibit 6.21 contains all of the data points for this trade.
To drill this concept down even further, you can see more trade exam-

QMFT PO XXX USBEFSTDIPJDFPQUJPOT OFU %FDJEJOH PO XIFO UP HFU PVU FBSMZ
and when to hold until expiration is something that you have to determine
based on your desired profitability and risk tolerance. It will be further
discussed in our strategy guides and courses.

Of course, when exiting long and/or short trades early, you will still
have to pay commission when you exit the trade.

94 BINARY OPTIONS

EXHIBIT 6.21 Data Points for Short Binary Option Trade Demonstrating Early
Exit to Cut Losses

Trade Figure Calculation

Underlying asset S&P futures ($100 – bid price) × number of
Market price 1250 contracts = collateral
Expiration 1 day ($100 – $26) × 1 =
Strike price 1256 $74 × 1 = $74
Long/Short Short (sell) Collateral = max loss
Size 1 contract Bid price × number of contracts
Price Bid price of $26/contract = max profit
Max loss $74 $26 × 1 = $26.

Collateral $74 Bid price when position opened
Max profit $26 – ask price when position closed
= profit
Exit price Ask price of $55/contract $26 – $55 = –$29
Profit or loss Loss of $29

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

CHAPTER 7

Keys to Trading
Binary Options

and More
Examples

L et’s review some key facts to remember when trading binary
options:

t F act 1: If the market price is above the strike price at expiration, the
contract value goes to $100. If the market price is below the strike
price at expiration, the contract value goes to $0.

t Fact 2: You can always trade in and out of a binary option contract any
time before expiration and settlement.

t Fact 3: The collateral you put up for a binary option trade is always
equivalent to your maximum loss on the trade.

t F act 4: Binary options have no calls or puts. They simply have condi-
tions (also known as strike prices) that you can speculate on to be true
or not. If you believe a condition to be true by expiration, you buy the
binary option; if you would like to speculate for it to be false, you sell
the binary option on that condition.

t Fact 5: You can never lose more than you put into a binary options
trade. You put up your maximum loss as the collateral and can never
lose more than you put up on your trade.

t F act 6: The most collateral any contract will require you to put up on
a trade is $100; typically, the collateral you put up will be less than $100
on any binary option contract.

t F act 7: When trading a binary option, if you are correct on your trade at
expiration, your account will always be credited $100 per contract. If you
are incorrect at expiration, your account will always receive nothing.

95

96 BINARY OPTIONS

Taking these facts into consideration, let’s look at some simple trade
examples to solidify the concepts.

GOLD BINARY EXAMPLES

Based on the option chain in Exhibit 7.1, let’s look at some possible trade
examples based on gold binary options.

Exhibit 7.1 is an image of an option chain of gold binary options strike
prices with 12 hours until expiration.

Gold (Feb) > 1730.5 15.00 20.00
Gold (Feb) > 1720.5 27.00 32.50
Gold (Feb) > 1710.5 41.50 47.50
Gold (Feb) > 1700.5 56.00 62.50
Gold (Feb) > 1690.5 71.00 76.50
Gold (Feb) > 1680.5 83.00 88.00
Gold (Feb) > 1670.5 91.00 95.50
Gold (Feb) > 1660.5 95.50
Gold (Feb) > 1650.5 96.00 -
Gold (Feb) > 1640.5 96.00 -
Gold (Feb) > 1630.5 96.00 -
Gold (Feb) > 1620.5 96.00 -
Gold (Feb) > 1610.5 96.00 -
-

EXHIBIT 7.1 Gold Binary Option Chain

Buy: At‐the‐Money Example
Let’s review the following at-the-money trade example:

Rationale Gold futures are currently trading at 1700.5. You assume that
gold futures will be above 1700.5 at expiration.

Entry Breakdown You buy one contract of gold binary options with a
strike price of 1700.5 and an ask price of $62.5 per contract. The required
collateral to place this trade is $62.5, which is your maximum potential loss
on the trade.

Exit Breakdown If the market closes above 1700.5 at expiration, the
contract will be worth $100 and you will make a profit of $37.5 per contract
or 60 percent on your trade.

However, if the market closes below 1700.5, the option will expire
worthless and you will lose $62.5 per contract.

Keys to Trading Binary Options and More Examples 97

Exhibit 7.2 depicts the profit and loss (P&L) of going long the 1700.5
gold binary option. The x‐axis represents the price of the underlying, and
the y‐axis represents P&L.

Profit 100 Long one contract of “> 1700.5” binary option
75
1700.5
50 binary option

25 Max Profit = $37.5
0
Price of
–25 Underlying
(Gold Futures)
–50
Max Loss = $62.5
–75
Loss –100 Market Price The light grey shaded area represents
(= 1700.5) the maximum loss for one contract.

The dark grey shaded area represents
the maximum profit for one contract.

EXHIBIT 7.2 P&L Graph of a Long At‐the‐Money Binary Option Trade

Summary Exhibit 7.3 contains all of the data points for this trade.

EXHIBIT 7.3 Data Points for Long At‐the‐Money Binary Option Trade

Trade Figure Calculation

Underlying asset price Gold futures Ask price × number of contracts = max
Market price 1700.5 loss
Expiration 1 day $62.5 × 1 = $62.5
Strike price 1700.5 collateral = max loss
Long/Short Long (buy) ($100 – ask price) × number of
Size 1 contract contracts = max profit ($100 – $62.5)
Price Ask price of × 1 = $37.5 × 1 = $37.5
$62.5/contract Max profit / max loss = risk vs. reward
Max loss $62.5 $37.5 / $62.5 = .6:1

Collateral $62.5
Max profit $37.5

Risk vs Reward .6:1

98 BINARY OPTIONS

Sell: Out‐of‐the‐Money Example

Let’s review the following out‐of-the-money trade example:

Rationale Gold futures are currently trading at 1690. You assume that
gold futures will go down and close below 1680 at expiration.

Entry Breakdown You sell three contracts of gold binary options
with a strike price of 1680.5 and a bid price of $83 per contract. In order
to get into the position, you will need to put up $17 in collateral per con-
tract (this is the difference between the option premium and $100), for a
total of $51.

Exit Breakdown If gold futures go below 1680, you will win on your
trade and your account will be credited $100 per contract. If you subtract
the $17 per contract collateral from this revenue, your profit will be the
option’s premium, $83 per contract, for a total of $249. However, if the mar-
ket stays above $1680, you will lose the $17 per contract collateral for a
total loss of $51.

Exhibit 7.4 depicts the P&L of going short the 1680 gold binary option.
The x‐axis represents the price of the underlying, and the y‐axis represents
profit and loss.

Profit 400 Short three contracts of “> 1680.5” binary option
300
1980.5
binary option

200 Max Profit = $249
100
Max Loss = $51 Price of
0 Underlying
–100 (Gold Futures)

–200 Market Price The light grey shaded area represents
–300 (= 1690) the maximum loss for three contracts.
Loss –400
The dark grey shaded area represents
the maximum profit for three contracts.

EXHIBIT 7.4 P&L Graph of a Short Out‐of‐the‐Money Binary Option Trade

Summary Exhibit 7.5 contains all of the data points for this trade.

Keys to Trading Binary Options and More Examples 99

EXHIBIT 7.5 Data Points for Short Out‐of‐the‐Money Binary Option Trade

Trade Figure Calculation

Underlying asset Gold futures
Market price
Expiration 1690
Strike price
Long/Short 1 day
Size
Price 1680.5

Max loss Short (sell)

Collateral 3 contracts
Max profit
Bid price
Risk vs. reward
of $83/

contract

$51 ($100 – bid price) × number of contracts = max

loss

($100 – $83) × 3 = $17 × 3 = $51

$51 Collateral = max loss

$249 Bid price × number of contracts = max profit

$83 × 3 = $249

4.88:1 Max profit / max loss = risk vs. reward

$249 / $51 = 4.88

COPPER BINARY EXAMPLES

Exhibit 7.6 is an image of an option chain of copper binary options strike
prices with 12 hours until expiration. Based on this option chain, let’s look
at some possible trade examples based on copper binary options.

Copper (Mar) > 404.5 - 10.00
Copper (Mar) > 399.5 - 10.00
Copper (Mar) > 394.5 5.50 16.00
Copper (Mar) > 389.5 21.00 31.50
Copper (Mar) > 384.5 44.00 54.50
Copper (Mar) > 379.5 67.50 78.00
Copper (Mar) > 374.5 84.00 94.50
Copper (Mar) > 369.5 90.00
Copper (Mar) > 364.5 90.00 -
Copper (Mar) > 359.5 90.00 -
Copper (Mar) > 354.5 90.00 -
Copper (Mar) > 349.5 90.00 -
Copper (Mar) > 344.5 90.00 -
-

EXHIBIT 7.6 Copper Binary Option Chain

100 BINARY OPTIONS

Buy: In‐the‐Money Example
Let’s review the following in‐the‐money trade example:

Rationale Copper futures are currently trading at 384.5. You forecast
that copper futures will stay above 379.5 at expiration.

Entry Breakdown You buy five contracts of copper binary options with
a strike price of 379.5 and an ask price of $78 per contract. The required
collateral to place this trade is the premium of $390 ($78 × 5), which is also
your maximum loss.

Exit Breakdown If copper futures close above 379.5 at expiration, each
contract will be worth $100 and you will make a profit of $22 per contract
or 28 percent on your trade. On a five‐contract position, you will make a
profit of $110 on this trade.

However, if copper futures close below 379.5, the option will expire
worthless. The collateral you put up here is $78 per contract, which is
the price of the option. On a five‐contract position your loss is $390, the
collateral.

Exhibit 7.7 depicts the P&L of going long the 379.5 copper binary op-
tion. The x‐axis represents the price of the underlying, and the y‐axis rep-
resents P&L.

Profit 400 Long five contracts of “> 379.5” binary option
300
200 379.5
binary option

100 Max Profit = $110 Price of
0 Underlying
(Copper Futures)
–100
–200 Max Loss = $390 The light grey shaded area represents
the maximum loss for five contracts.

–300 Market Price The dark grey shaded area represents
Loss –400 (= 384.5) the maximum profit for five contracts.

EXHIBIT 7.7 P&L Graph of a Long In‐the‐Money Binary Option Trade

Keys to Trading Binary Options and More Examples 101

Summary Exhibit 7.8 contains all of the data points for this trade.

EXHIBIT 7.8 Data Points for Long In‐the‐Money Binary Option Trade

Trade Figure Calculation

Underlying asset Copper futures Ask price × number of contracts = max loss
Market price 384.5 $78 × 5 = $390
Expiration 1 day Collateral = max loss
Strike price 379.5 ($100 – ask price) × number of contracts =
Long/Short Long (buy) max profit
Size 5 contracts ($100 – $78) × 5 =
Price Ask price of $22 × 5 = $110
$78/contract Max profit / max loss = risk vs. reward
Max loss $390 $110 / $390 = .28:1

Collateral $390
Max profit $110

Risk vs. reward .28:1

Sell: At‐the‐Money Example

Rationale Copper futures are currently trading at 384.5. You assume
that copper futures will drop below 384.5 at expiration.

Entry Breakdown You sell one contract of copper binary options with
a strike price of 384.5 and a bid price of $44 per contract. In order to get
into the position, you will need to put up $56 in collateral.

Exit Breakdown If the copper futures go below 384.5, you will win on
your trade and your account will be credited revenue of $100 per contract.
After subtracting the collateral, your profit per contract will be $44. How-
ever, if the market stays above $384.5, you will lose your collateral of $56
per contract.

Exhibit 7.9 depicts the P&L of going short the 384.5 copper binary op-
tion. The x‐axis represents the price of the underlying, and the y‐axis rep-
resents P&L.

102 BINARY OPTIONS

Profit 100 Short one contract of “> 384.5” binary option
75 384.5
50
binary option

25 Max Profit = $44 Price of
0 Underlying
–25 (Copper Futures)
–50
Max Loss = $56

–75 The light grey shaded area represents
Loss –100 the maximum loss for one contract.

Market Price The dark grey shaded area represents
(= 384.5) the maximum profit for one contract.

EXHIBIT 7.9 P&L Graph of a Short At‐the‐Money Binary Option Trade

Summary Exhibit 7.10 contains all of the data points for this trade.
To see even more trade examples based on the theories you just

learned, simply visit our companion site, www.traderschoiceoptions
.net.

EXHIBIT 7.10 Data Points for Short At‐the‐Money Binary Option Trade

Trade Figure Calculation

Underlying asset Copper futures
Market price
Expiration 384.5
Strike price
Long/Short 1 day
Size
Price 384.5

Max loss Short (sell)

Collateral 1 contract
Max profit
Bid price of $44/
Risk vs. reward
contract

$56 ($100 – bid price) × number of contracts =

max loss

($100 – $44) × 1 =

$56 × 1 = $56

$56 Collateral = max loss

$44 Bid price × number of contracts = max profit

$44 × 1 = $44

.78:1 Max profit / max loss = risk vs. reward

$44 / $56 = .78:1

Keys to Trading Binary Options and More Examples 103

KEY POINTS: PART 3

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

t Binary options are fully collateralized. This means that regardless of
whether you are buying or selling an option, you cannot lose more than
you put up per contract on the trade.

t The collateral on a long binary option contract is always the premium.
t The collateral on a short binary option contract is always $100 minus the

premium.

t Regardless of whether you buy or sell a binary option, if you are correct at
expiration, your account will be credited $100 (settlement) per contract. If
you are incorrect, you will get nothing.

t If you hold a binary option until expiration and lose, your loss will always
be your collateral.

t If you hold a binary option trade until expiration and win, your profit is
always going to be equal to $100 minus your collateral.

t The profit on a successful short binary option trade is always the premium.
t The profit on a successful long binary option trade is always $100 minus

the premium.

t When trading binary options contracts, typically you are charged a com-
mission on each contract. With some brokers you will also be charged a
settlement fee if the option goes until expiration. You pay the settlement
fee only if you win on the trade.

t When reading a binary option quote, there are several fundamental compo-
nents that you should understand and identify:

t The underlying asset
t Strike price
t Expiration time and date
t Bid/Offer
t When reading a binary option order ticket, there are several fundamental
components that you should understand and identify:

t Contract information
t Bid and offer prices
t Order details
t Max profit, max loss, market ceiling, market floor

104 BINARY OPTIONS

t When trading binary options, you can exit your trade in two different ways:
(1) You can wait until expiration and have your trade settled at $0 or $100
per contract, or (2) you can exit your trade before expiration for the fair
market price.

t If you wait until expiration and your trade expires at a loss, then you will
simply lose your collateral and not get anything at expiration. This holds
true whether you bought or sold an options contract.

t If your trade ends up in‐the‐money at expiration, you will collect $100
regardless of whether you entered a short or a long position.

t You can trade in and out of binary options at any time up until expiration
to either lock in your profits or mitigate your losses.

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

PART IV

Binary Options
Trading Strategies

T his section will teach you some basic trading strategies that you can
implement with binary options.
What You Will Learn:
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options trading strategies.

105

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

CHAPTER 8

Volatility Trading
Explained

W ith binary options you are not limited to directional trading only.
Volatility trading presents a unique opportunity to trade based
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to go up or down in the short term. You can use binary options to simply
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107

108 BINARY OPTIONS

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when a trader assumes that an underlying asset will remain within a
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TAKING A VOLATILITY LONG POSITION
(BUYING VOLATILITY)

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500 Short Position Long Position

400

300
In a long volatility position,
you profit if the underlying

200 asset closes outside of either
the long or short position.

100

0

–100

–200 This line represents the
price of the underlying
asset.

EXHIBIT 8.1 P&L Graph of a Long Volatility Binary Option Trade

Volatility Trading Explained 109

Long Volatility Example

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DMPTFE CFMPX PS BCPWF
UIF USBEFS XJMM QSPåU

110 BINARY OPTIONS

500 Short Position Long Position

400

Potential profit on 300 In a long volatility position,
1 lot position 200 you profit if the underlying
(= $84.50) asset closes outside of either
the long or short position.

100

Potential loss on 0
1 lot position 1232 1235 1238 1241 1244 1247 1250 1253 1256 1259 1262 1265 1268
(= $15.50)
–100

–200 This line represents the Market Price
price of the underlying (=1250)
asset.

Collateral required to enact this intraday binary strategy: $15.50

EXHIBIT 8.2 P&L Graph of a Long Volatility Binary Option Trade

Summary &YIJCJU DPOUBJOT BMM PG UIF EBUB QPJOUT GPS UIJT USBEF

EXHIBIT 8.3 Data Points for Long Volatility Binary Option Trade

Trade Figure Calculation

Underlying asset S&P futures at 1250 (($100 – bid price) + ask price) ×
Market price 1250 number of contracts = max loss
Expiration 1 day (($100 – $92.3) + $7.8) X 1 = ($7.7
Strike price long 1265 + $7.8) × 1 = $15.50 × 1 = $15.50
Strike price short 1235 Collateral = max loss
Size long 1 contract $100 – total collateral = profit
Size short 1 contract $100 – $15.5 = $84.5
Price Ask price of $7.8/ Max profit / max loss = risk vs. reward
contract $84.5 / $15.5 = 5.45
Max loss Bid price of $92.3/
contract
$15.50

Total collateral $15.50
Max profit $84.50

Risk vs. reward 5.45:1

Volatility Trading Explained 111

REGULATING SUCCESS PROBABILITY AND
PAYOUT WITH STRIKE PRICES

8IFO USBEJOH MPOH WPMBUJMJUZ
UIF TUSJLF QSJDFT PG UIF PQUJPOT UIBU ZPV
DIPPTF XJMM EFUFSNJOF IPX MBSHF B NPWF ZPV OFFE JO PSEFS UP NBLF NPOFZ
/BUVSBMMZ
UIF MBSHFS B NPWF UIBU ZPV USZ UP QSFEJDU
UIF CJHHFS ZPVS QBZPVU
will be.

&YIJCJU TIPXT UIF SFMBUJPOTIJQ CFUXFFO BO BOUJDJQBUFE NPWFNFOU
BOE UIF QBZPVU PG B CJOBSZ PQUJPO 5ZQJDBMMZ
XIFO B USBEFS TQFDVMBUFT UIBU
BO VOEFSMZJOH XJMM IBWF B MBSHFS NPWF
UIF QBZPVU UFOET UP CF IJHIFS 5IJT
QIFOPNFOPO JT EJSFDUMZ SFMBUFE UP UIF QSPCBCJMJUZ PG UIF NPWF " TNBMMFS
NPWF DPVME CF DPOTJEFSFE NVDI NPSF MJLFMZ UIBO B MBSHFS NPWF

EXHIBIT 8.4 How the Size of a Move Affects the Potential Payout

Size of Move Speculated Payout

Larger Higher
Example: 20 points Example: $80 per contract
Smaller Less
Example: 10 points Example: $40 per contract

'PS FYBNQMF
MFU T BTTVNF UIBU UIF VOEFSMZJOH JT USBEJOH BU BOE ZPV
EFDJEF UP TQFDVMBUF UIBU JU XJMM NPWF BU MFBTU QPJOUT CZ FYQJSBUJPO 5P EP
UIJT
ZPV XPVME QVSDIBTF B TUSJLF QSJDF BOE TFMM BO TUSJLF QSJDF
5IF TUSJLF QSJDF NBZ DPTU
BOE UIF QVU NBZ DPTU &BDI PG
UIFTF PQUJPOT XPVME HJWF ZPV B QPUFOUJBM SFXBSE PG XJUI B SJTL PG

*G UIF NBSLFU NPWFT CZ BU MFBTU QPJOUT JO POF EJSFDUJPO PS BOPUIFS

ZPV XPVME UBLF JO UPUBM
XIJDI JT UIF TFUUMFNFOU GPS UIF XJOOJOH USBEF
#VU ZPV TQFOU UIF DPNCJOFE DPMMBUFSBM PG UIF MPOH BOE TIPSU QPTJUJPO



XIJDI JT UIF DPMMBUFSBM UIBU ZPV QVU VQ

"OPUIFS XBZ UP MPPL BU UIJT USBEF JT UIBU JG UIF 4 1 GVUVSFT NPWF JO POF
EJSFDUJPO CZ QPJOUT
ZPV XJMM NBLF
CVU ZPV XJMM BMTP MPTF PO UIF
PUIFS USBEF :PVS QSPåU JG ZPV XJO JT
XIJDI JT UIF QSPåU PO UIF XJOOJOH
MFH NJOVT UIF MPTT PO UIF MPTJOH MFH QPTJUJPO o


:PVS SFXBSE SJTL SBUJP PO UIF USBEF JT ZPVS NBYJNVN QSPåU PG
EJWJEFE CZ UIF NBYJNVN MPTT PG 5IF JT UIF UPUBM MPTT JG UIF VOEFS
MZJOH TUBZT XJUIJO UIF SBOHF PG UIF UXP TUSJLF QSJDFT 'PS UIJT FYBNQMF UIF
SFXBSE SJTL SBUJP XJMM CF EJWJEFE CZ PS

&YIJCJU EFQJDUT UIF 1 - PG HPJOH MPOH B CJOBSZ PQUJPO BOE TIPSU B
CJOBSZ PQUJPO 5IF YĄBYJT SFQSFTFOUT UIF QSJDF PG UIF VOEFSMZJOH
BOE UIF
y‐axis represents the P&L.

112 BINARY OPTIONS

Short one contract of “> 1190” binary option and long one contract “> 1210” binary option

Profit 100

75

1190 1210

50 binary option binary option

25 Profit = $20 Price of
Profit = $20 Underlying

0

–25 Max Loss = $80
–50
The light grey shaded area represents
–75 the max loss of one long contract and
Loss –100 one short contract.

Market Price The dark grey shaded area represents
(=1200) the profit of one long contract or one
short contract.

EXHIBIT 8.5 P&L Graph of a Long Volatility Binary Option Trade

)PXFWFS
JG ZPV BSF TQFDVMBUJOH UIBU UIF 4 1 GVUVSFT XJMM NPWF BU
MFBTU QPJOUT JO POF EJSFDUJPO PS BOPUIFS
ZPV XJMM PCWJPVTMZ IBWF B MPXFS
DIBODF PG XJOOJOH ZFU B CFUUFS QPUFOUJBM SFXBSE SJTL SBUJP *O PUIFS XPSET

you will get better payout odds.

6TJOH UIF TBNF FYBNQMF
JG UIF 4 1 GVUVSFT VOEFSMZJOH JT USBEJOH
BU
B PQUJPO NBZ DPTU ZPV BOE ZPV NBZ CF BCMF UP TFMM BO

Short one contract of “> 1180” binary option and long one contract “> 1220” binary option

Profit 100 1180 1220
75 binary option binary option

50 Profit = $60
Profit = $60
Price of
25 Underlying

0 Max loss = $40

–25

–50 Market Price The light grey shaded area represents
(=1200) the combined loss of one long contract
–75 and one short contract.
Loss –100
The dark grey shaded area represents
the profit of one long contract or one
short contract.

EXHIBIT 8.6 P&L Graph of a Long Volatility Binary Option Trade

Volatility Trading Explained 113

PQUJPO GPS 5IJT XJMM HJWF ZPV UIF TBNF QPUFOUJBM QBZPVU
CVU
ZPVS SJTL JO UIJT DBTF JT POMZ 5IJT XJMM HJWF ZPV B QSPåU JG ZPV XJO
4P JG UIF 64 EPFT NPWF QPJOUT JO POF EJSFDUJPO PS BOPUIFS
ZPV XJMM
IBWF B SFXBSE SJTL SBUJP PG
JOTUFBE PG UIF SFXBSE SJTL SBUJP
EJTDVTTFE JO UIF QSFWJPVT FYBNQMF

&YIJCJU EFQJDUT UIF QSPåU BOE MPTT PG HPJOH MPOH B CJOBSZ PQUJPO BOE
TIPSU B CJOBSZ PQUJPO 5IF YĄBYJT SFQSFTFOUT UIF QSJDF PG UIF VOEFSMZJOH
BOE
the y‐axis represents the profit and loss.

TAKING A VOLATILITY SHORT POSITION
(SELLING VOLATILITY)

:PV XPVME TFMM WPMBUJMJUZ JG ZPV GFMU UIBU UIF VOEFSMZJOH BTTFU XPVME SFNBJO
JO B DFSUBJO SBOHF CZ FYQJSBUJPO 5IJT TUSBUFHZ TFFLT UP QSPåU GSPN WPMBUJM
JUZ TMPXJOH EPXO BOE QSJDF TUBZJOH XJUIJO B HJWFO SBOHF 5IJT UZQF PG USBEF
NBZ CF SFGFSSFE BT B TIPSU WPMBUJMJUZ USBEF BMTP LOPXO BT B TIPSU TUSBOHMF

8JUI B TIPSU TUSBOHMF
B USBEFS XJMM TFMM B CJOBSZ PQUJPO BU UIF UPQ PG UIF
SBOHF BOE CVZ B CJOBSZ PQUJPO BU UIF CPUUPN PG UIF SBOHF (PJOH TIPSU WPMB
UJMJUZ JT UIF FYBDU PQQPTJUF PG HPJOH MPOH WPMBUJMJUZ

&YIJCJU EFQJDUT UIF QSPåU BOE MPTT PG HPJOH MPOH B CJOBSZ PQUJPO BOE
TIPSU B CJOBSZ PQUJPO 5IF YĄBYJT SFQSFTFOUT UIF QSJDF PG UIF VOEFSMZJOH
BOE
UIF ZĄBYJT SFQSFTFOUT UIF QSPåU BOE MPTT *G BU FYQJSBUJPO UIF VOEFSMZJOH IBT
DMPTFE CFMPX UIF TIPSU QPTJUJPO BOE PS BCPWF UIF MPOH QPTJUJPO
UIF USBEFS
will profit.

300

200 In a short volatility This line represents the
trade, you profit

if the underlying price of the underlying

closes below your market.

100 short position or

above your long

position.

0

–100

–200

–300

Long Position Short Position

EXHIBIT 8.7 P&L Graph of a Short Volatility Binary Option Trade

114 BINARY OPTIONS

Short Volatility Example

-FU T MPPL BU B TQFDJåD USBEF FYBNQMF UP HFU B CJU NPSF DMBSJUZ

Rationale *O &YIJCJU UIF NBSLFU QSJDF PG UIF 64 JT " USBEFS
TQFDVMBUFT UIBU UIF 4 1 GVUVSFT XJMM SFNBJO JO B SBOHF
TUBZJOH BCPWF
BOE CFMPX

300 This line is a
representation
Potential profit on 200 of profit or loss This line represents
1 lot position 100 in dollars. the price of the
(= $52.10) underlying market.

0
1232 1235 1238 1241 1244 1247 1250 1253 1256 1259 1262 1265 1268

Potential loss on –100
1 lot position –200
(= $47.9)

–300 Market Price
(=1250)

EXHIBIT 8.8 P&L Graph of a Short Volatility Binary Option Trade

Entry Breakdown " USBEFS TPME POF DPOUSBDU PG UIF 64 CJ
OBSZ PQUJPO GPS
BOE BMTP CPVHIU POF DPOUSBDU PG UIF 64
CJOBSZ PQUJPO GPS 5IF DPMMBUFSBM GPS UIJT USBEF JT
XIJDI JT UIF
DPMMBUFSBM PG UIF MPOH QPTJUJPO

BEEFE UP UIF DPMMBUFSBM PG UIF TIPSU
QPTJUJPO
o


Long‐Trade Logic 4JODF ZPV BSF BTTVNJOH UIBU UIF 4 1 GVUVSFT
XJMM TUBZ XJUIJO ZPVS EFTJSFE SBOHF
ZPV XPVME QVU VQ GPS UIF i w
PQUJPO BOE IPQF UIBU UIF QSJDF XPVME JOEFFE DMPTF HSFBUFS UIBO
XIJDI
XPVME HJWF ZPV B UPUBM QBZPVU PO UIF PQUJPO GPS B QPUFOUJBM QSPåU
PG QFS DPOUSBDU o


Short‐Trade Logic 8JUI UIF TIPSU QPTJUJPO
ZPV BSF BTTVNJOH UIBU
UIF VOEFSMZJOH XJMM TUBZ JO UIF EFTJSFE SBOHF BOE UIFSFGPSF JU XJMM OPU
DSPTT BCPWF 4P ZPV TFMM TIPSU TFMM
UIF i w PQUJPO :PV XPVME
QVU VQ JO DPMMBUFSBM UIJT JT UIF EJGGFSFODF CFUXFFO BOE UIF
QSFNJVN PG UIF PQUJPO ZPV TFMM
"T MPOH BT UIF NBSLFU EPFT OPU HP
BCPWF
ZPV XJMM SFDFJWF UIF TFUUMFNFOU PG
GPS B QSPåU PG
o

Volatility Trading Explained 115

Total Collateral :PVS UPUBM DPMMBUFSBM PO UIF TQSFBE JT 5IJT JT
PQUJPO QSFNJVN GPS UIF MPOH USBEF QMVT DPMMBUFSBM GPS UIF TIPSU
USBEF o


Exit Breakdown

Maximum Risk *G
IPXFWFS
UIF 4 1 GVUVSFT NPWF PVUTJEF PG FJUIFS
TUSJLF QSJDF
UIF USBEFS XJMM MPTF 5IF DBMDVMBUJPOT GPS UIFTF OVNCFST
are explained below.

8IFO HPJOH TIPSU WPMBUJMJUZ ZPV DBOOPU MPTF PO CPUI MFHT PG ZPVS QPTJ
UJPO BU UIF TBNF UJNF JG ZPV IPME VOUJM FYQJSBUJPO 5IF GVUVSFT DBOOPU CF
CPUI CFMPX BOE BCPWF BU UIF TBNF UJNF 5IFSFGPSF
ZPV IBWF UP
XJO PO BU MFBTU POF PG ZPVS QPTJUJPOT JG ZPV IPME VOUJM FYQJSBUJPO

Upper Strike Price Breach :PVS NBYJNVN SJTL JG UIF 4 1 GV
UVSFT DMPTF BCPWF BU FYQJSBUJPO JT FRVBM UP UIF HBJO GSPN UIF
i w PQUJPO UIBU ZPV CPVHIU NJOVT UIF MPTT PO UIF i w PQUJPO
UIBU ZPV TPME NJOVT FRVBMT B UPUBM MPTT PG

Lower Strike Price Breach :PVS NBYJNVN SJTL JG UIF 4 1 GV
UVSFT DMPTF CFMPX BU FYQJSBUJPO JT FRVBM UP UIF QSPåU UIBU ZPV UBLF
JO PO UIF i w PQUJPO NJOVT UIF MPTT UIBU ZPV XJMM JODVS XJUI UIF
i w PQUJPO 5IJT BMTP FRVBMT B UPUBM MPTT PG

/PX MFU T MPPL BU XIBU IBQQFOT JG UIF VOEFSMZJOH TUBZT CFUXFFO
BOE CZ FYQJSBUJPO

Maximum Reward *G UIF 64 TUBZT CFUXFFO BOE BU FYQJSB
UJPO
ZPVS DBTI JOýPX XPVME CF PO CPUI UIF MPOH BOE UIF TIPSU PQUJPOT
4P ZPV XPVME DPMMFDU B UPUBM PG BU FYQJSBUJPO 5P åOE PVU ZPVS QSPåU
TJN
QMZ TVCUSBDU UIF DPMMBUFSBM UIBU ZPV QVU VQ GSPN ZPVS DBTI JOýPX BU FYQJSBUJPO

"T ZPV SFDBMM
ZPVS UPUBM DPMMBUFSBM JT 4VCUSBDU UIBU OVNCFS GSPN
UIF SFWFOVF BU FYQJSBUJPO BOE ZPV BSSJWF BU B NBYJNVN QSPåU PG

Reward/Risk Ratio :PVS SFXBSE SJTL SBUJP PO UIJT USBEF JT TJNQMZ FRVBM
UP NBY QSPåU BU FYQJSBUJPO
EJWJEFE CZ NBY SJTL BU FYQJSBUJPO

PS

&YIJCJU EFQJDUT UIF QSPåU BOE MPTT PG HPJOH MPOH UIF CJOBSZ
PQUJPO BOE TIPSU UIF CJOBSZ PQUJPO XIFO UIF VOEFSMZJOH JOTUSVNFOU JT
USBEJOH BU 5IF YĄBYJT SFQSFTFOUT UIF QSJDF PG UIF VOEFSMZJOH BOE UIF
ZĄBYJT SFQSFTFOUT UIF 1 - *G BU FYQJSBUJPO UIF VOEFSMZJOH IBT DMPTFE CFMPX
BOE BCPWF
UIF USBEFS XJMM QSPåU

Summary &YIJCJU DPOUBJOT BMM PG UIF EBUB QPJOUT GPS UIJT USBEF

116 BINARY OPTIONS

EXHIBIT 8.9 Data Points for Short Volatility Binary Option Trade

Trade Figure Calculation

Underlying asset S&P futures (Ask price + ( $100 – bid price)) ×
Market price 1250 number of contracts = total collateral
Expiration 1 day ($73.9 + ($100 – $26)) × 1 = ($73.9 +
Strike price long 1244 $74) × 1= $147.9 × 1 = $147.9
Strike price short 1256 Higher of:
Size long 1 contract (collateral of short position – profit of
Size short 1 contract long position) × number of contracts =
Price Ask price of > 1244 max loss
contract: $73.9 (($100 – $26) – ($100 – $73.9)) × 1 =
Total collateral Bid price of > 1256 ($74 – $26.1) × 1 = $47.9 × 1
contract: $26 Or
Max loss $147.9 (collateral of long position – profit of
short position) × number of contracts =
Max profit $47.9 max loss
Risk vs. reward ($73.9 – $26) × 1 = $47.9 × 1 = $47.9
$52.1 Revenue – total collateral = max profit
1.09:1 $200 – $147 = $52.1
Max profit / max loss = risk vs. reward
$52.1 / $47.9 = 1.09:1

&YIJCJU EFQJDUT UIF NBYJNVN MPTT BOE NBYJNVN HBJO GPS FBDI MFH
PG UIF TIPSU WPMBUJMJUZ USBEF BCPWF 5IF MJHIU HSFZ TIBEFE BSFB SFQSFTFOUT
UIF NBYJNVN QSPåU GPS FBDI QPTJUJPO
BOE UIF EBSL HSFZ TIBEFE BSFB SFQSF
TFOUT UIF NBYJNVN MPTT GPS FBDI QPTJUJPO

REGULATING RANGE AND PAYOUT WITH STRIKE PRICES

+VTU MJLF XJUI HPJOH MPOH WPMBUJMJUZ
ZPV EFUFSNJOF ZPVS EFTJSFE SBOHF UP
TQFDVMBUF PO BOE QBZPVU PEET CZ UIF TUSJLF QSJDFT UIBU ZPV DIPPTF 5IF
GBSUIFS BXBZ UIF TUSJLF QSJDFT UIBU ZPV DIPPTF
UIF NPSF MJLFMZ ZPV BSF UP

Volatility Trading Explained 117

Buy 1 @ 73.9 Sell 1 @ 26
100 100

75 75

50 50
25 25

00

EXHIBIT 8.10 Graphical Representation of the P&L on Both the Long and Short
Position

XJO PO ZPVS USBEF "U UIF TBNF UJNF
UIF GBSUIFS UIF TUSJLF QSJDFT UIBU ZPV
DIPPTF
UIF MPXFS ZPVS QBZPVU PEET XJMM CF

*G ZPV TQFDVMBUF UIBU UIF VOEFSMZJOH XJMM TUBZ JO B UJHIUFS SBOHF
ZPV
XPVME DIPPTF UP USBEF DMPTFS TUSJLF QSJDFT 4JODF JU JT MFTT MJLFMZ UIBU ZPVS
VOEFSMZJOH XPVME TUBZ JO B UJHIUFS SBOHF UIBO B XJEFS POF
ZPVS QBZPVU PEET
(return on collateral) will be higher than with a wider range.

&YIJCJU JT BO PQUJPO DIBJO PG 64 CJOBSZ PQUJPOT XJUI IPVST
VOUJM FYQJSBUJPO "T ZPV DBO TFF
UIF PQUJPOT GBSUIFS BXBZ GSPN UIF VOEFSMZ
JOH T NBSLFU QSJDF SFRVJSF NPSF DPMMBUFSBM QBZ MFTT QSFNJVN
UP HP TIPSU
WPMBUJMJUZ "OE UIF PQUJPOT DMPTFS UP UIF NBSLFU QSJDF PG UIF VOEFSMZJOH SF
RVJSF MFTT DPMMBUFSBM QBZ NPSF QSFNJVN
UP HP TIPSU WPMBUJMJUZ 5IJT JT TJN
QMZ EVF UP UIF GBDU UIBU UIF VOEFSMZJOH JT NPSF MJLFMZ UP FOE VQ JO B XJEFS
range than a narrower range at expiration.

Contract Bid Offer
Daily US 500 (Mar) > 1268 2.1 5
7.8
Daily US 500 (Mar) > 1265 4.9
12.7
Daily US 500 (Mar) > 1262 9.7 20
29
Daily US 500 (Mar) > 1259 17 40.1
51.6
Daily US 500 (Mar) > 1256 26 63.1
73.9
Daily US 500 (Mar) > 1253 36.1 83.4
90.4
Daily US 500 (Mar) > 1250 48.1 95.3
98.4
Daily US 500 (Mar) > 1247 60.1

Daily US 500 (Mar) > 1244 71.2

Daily US 500 (Mar) > 1241 79.9

Daily US 500 (Mar) > 1238 87.4

Daily US 500 (Mar) > 1235 92.3

Daily US 500 (Mar) > 1232 95.4

12 hours to expiration, futures trading at 1250

EXHIBIT 8.11 Binary Option Chain

118 BINARY OPTIONS

&YIJCJU JT BO JNBHF PG B OPSNBM EJTUSJCVUJPO DVSWF %VF UP UIF QSJO
DJQMF PG OPSNBM EJTUSJCVUJPO
UIF QSJDF PG B USBEBCMF JOTUSVNFOU IBT B IJHIFS
QSPCBCJMJUZ PG FWFOUVBMMZ FOEJOH VQ XIFSF JU TUBSUFE 5P HFU B SFBMJTUJD QJD
UVSF PG IPX NVDI UIF 4 1 NPWFT JO B HJWFO EBZ PS XFFL
ZPV DBO DIFDL PVU
our distribution tool at www.traderschoiceoptions.net.

'PS FYBNQMF
UIF 64 JT NPSF MJLFMZ UP FOE VQ JO B QSJDF SBOHF CF
UXFFO BOE UIBO JO B SBOHF CFUXFFO BOE

US S&P 500

less likely

more likely

1235 1245 1256 1265

Normal Distribution Curve

EXHIBIT 8.12 A Normal Distribution Curve

-FU T MPPL GVSUIFS BU UIJT FYBNQMF UP ESJWF UIF DPODFQU IPNF 5IF TIPSU
WPMBUJMJUZ FYBNQMF EFNPOTUSBUFE UIBU UP TQFDVMBUF UIBU UIF 4 1 GVUVSFT
XPVME FOE VQ JO B QSJDF SBOHF CFUXFFO BOE
ZPV XPVME OFFE
UP QVSDIBTF UIF i w PQUJPO GPS DPMMBUFSBM QFS DPOUSBDU
BOE ZPV
XPVME OFFE UP TFMM UIF i w PQUJPO GPS DPMMBUFSBM QFS DPOUSBDU :PVS
UPUBM DPMMBUFSBM JT
BOE ZPVS QPUFOUJBM JOýPX JG UIF 4 1 GVUVSFT
TUBZ XJUIJO ZPVS EFTJSFE SBOHF JT 5IFSFGPSF
ZPVS NBYJNVN QSPåU JT
o PS :PVS NBYJNVN SJTL JT o o


TP
ZPVS SFXBSE SJTL SBUJP JT PS

&YIJCJU EFQJDUT UIF 1 - PG HPJOH MPOH UIF CJOBSZ PQUJPO BOE
TIPSU UIF CJOBSZ PQUJPO 5IF YĄBYJT SFQSFTFOUT UIF QSJDF PG UIF VOEFSMZ
JOH
BOE UIF ZĄBYJT SFQSFTFOUT UIF 1 -

*G ZPV XBOU UP TQFDVMBUF UIBU UIF 4 1 GVUVSFT XJMM TUBZ JO B XJEFS
SBOHF
TBZ CFUXFFO BOE
ZPV XPVME EP UIF GPMMPXJOH :PV XPVME
QVSDIBTF UIF i w PQUJPO GPS DPMMBUFSBM QFS DPOUSBDU BOE TFMM UIF
i w PQUJPO GPS DPMMBUFSBM QFS DPOUSBDU XPVME CF NJOVT UIF
PQUJPO QSFNJVN PS
:PVS UPUBM DPMMBUFSBM XJMM CF

:PVS UPUBM QPUFOUJBM JOýPX XJMM CF BT MPOH BT UIF NBSLFU TUBZT
XJUIJO ZPVS EFTJSFE SBOHF 5IFSFGPSF
ZPVS UPUBM QPUFOUJBM QSPåU XJMM CF
QFS DPOUSBDU
XIJDI JT NJOVT

*G ZPV IPME UIJT USBEF VOUJM FYQJSBUJPO BOE UIF 4 1 GVUVSFT HP CFMPX
BU FYQJSBUJPO
ZPV XPVME MPTF QFS DPOUSBDU PO UIBU MFH )PXFWFS

ZPV XPVME TUJMM HFU UP LFFQ QFS DPOUSBDU UIBU ZPV XPVME DPMMFDU GSPN
UIF MFH 5IJT XJMM HJWF ZPV B OFU MPTT PG o


*G UIF 64 HPFT BCPWF BU FYQJSBUJPO
UIFO ZPV XPVME MPTF
PO UIF TIPSU i w DPOUSBDU IPXFWFS
ZPV XPVME TUJMM NBLF PO UIF
MPOH i w DPOUSBDU 5IJT XPVME HJWF ZPV B OFU MPTT PG o

Volatility Trading Explained 119

Short one contract of “> 1256” binary option and long one contract of “> 1244” binary option

Profit 100 1244 1256
75 binary option binary option

50 Price of
25 Max Profit = $52.1 Underlying

0 loss = $47.9

–25 loss = $47.9

–50 Market Price The light grey shaded area represents
(=1200) the loss of one long contract and the
–75 loss of one short contract.
Loss –100
The dark grey shaded area represents
the combined profit of one long
contract and one short contract.

EXHIBIT 8.13 P&L Graph of a Short Volatility Binary Option Trade

5IFSFGPSF
PO UIJT QBSUJDVMBS USBEF
ZPVS NBY MPTT JT BOE ZPVS NBY
QSPåU JT 5IJT HJWFT ZPV B SFXBSE SJTL SBUJP PG 4JNQMZ EJWJEF
CZ UP DPNF VQ XJUI UIJT OVNCFS

&YIJCJU EFQJDUT UIF 1 - PG HPJOH MPOH UIF CJOBSZ PQUJPO BOE
TIPSU UIF CJOBSZ PQUJPO 5IF YĄBYJT SFQSFTFOUT UIF QSJDF PG UIF VOEFSMZ
JOH
BOE UIF ZĄBYJT SFQSFTFOUT UIF 1 -

Short one contract of “> 1265” binary option and long one contract “> 1235” binary option
Profit 100

75

50 1235 1265
binary option binary option

25

0 Potential Profit = $9.6 Price of
Underlying

–25 loss
loss = $95.1

–50 = $95.3 Market Price
(=1250)
–75
Loss –100 The light grey shaded area represents the
loss of one long contract and the loss of
one short contract.

The dark grey shaded area represents the
combined profit of one long contract and
one short contract.

EXHIBIT 8.14 P&L Graph of a Short Volatility Binary Option Trade

120 BINARY OPTIONS

"T ZPV DBO TFF CZ UIJT FYBNQMF
UIF MBSHFS B QSJDF SBOHF UIBU ZPV
CFU UIF VOEFSMZJOH XJMM FOE VQ JO BU FYQJSBUJPO
UIF MPXFS ZPVS QBZPVU
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SBOEPNMZ TQJU PVU B OVNCFS CFUXFFO BOE BOE QBZ ZPV JG ZPV HVFTT
DPSSFDUMZ "MTP
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ZPVS QBZPVU SBUJP JT HPJOH UP
ESPQ XJUI FWFSZ HVFTT ZPV NBLF 1JDLJOH B XJEFS SBOHF XIFO HPJOH TIPSU
WPMBUJMJUZ JT TJNQMZ MJLF NBLJOH NPSF HVFTTFT PG XIFSF UIF QSJDF XJMM FOE
up at expiration.

#BTFE PO UIJT FYBNQMF
ZPV TIPVME OPX TFF UIBU CZ USBEJOH WPMBUJMJUZ
XJUI CJOBSZ PQUJPOT
ZPV DPOUSPM ZPVS QSPCBCJMJUZ UP XJO BOE ZPVS QBZPVU
SBUJP CZ NPEJGZJOH UIF TUSJLF QSJDFT UIBU ZPV USBEF

MAX LOSS, COLLATERAL, AND MAX PROFIT
SUMMARY TABLE

&YIJCJU XJMM IFMQ ZPV SFNFNCFS IPX UP DBMDVMBUF UIF NBY MPTT
NBY
QSPåU
BOE DPMMBUFSBM GPS MPOH
TIPSU
WPMBUJMJUZ MPOH
BOE WPMBUJMJUZ TIPSU CJ
nary option trades.

EXHIBIT 8.15 Max Loss, Max Profit, and Collateral Table for Binary Option
Trades and Spreads at Expiration

Type of Max Loss Max Profit Collateral
trade

Long Premium $100 – premium Premium
Short $100 – premium
Volatility Premium long leg + ($100 – Premium $100 – Premium
long premium short leg)
$100 – (Collateral Long leg: Premium
Volatility
short long leg + collateral short leg ($100 –

short) premium)

Total: Premium

long + ($100 –

premium short)

Higher of Premium short leg Premium long leg
Lower breach: + ($100 – premium + ($100 – premium
Premium long leg – premium long leg) short leg)
short leg
Or
Upper breach:
($100 – Premium short leg) –
($100 – premium long leg) 

Volatility Trading Explained 121

"T ZPV DBO TFF GSPN UIF UBCMF
UIF DPMMBUFSBM JT FRVBM UP UIF NBY MPTT GPS
BMM UZQFT PG USBEFT FYDFQU GPS WPMBUJMJUZ TIPSU "MTP
ZPV DBO TFF UIBU UIF NBY
QSPåU JT TJNQMZ NJOVT DPMMBUFSBM GPS BMM FYBNQMFT FYDFQU GPS WPMBUJMJUZ
TIPSU 'PS WPMBUJMJUZ TIPSU
NBY QSPåU DBO CF DBMDVMBUFE CZ TVCUSBDUJOH UPUBM
DPMMBUFSBM GSPN PS CZ BEEJOH UIF QSFNJVN GPS UIF TIPSU MFH UP o
QSFNJVN GPS UIF MPOH MFH
1MFBTF LFFQ JO NJOE UIBU BMM UIFTF FYBNQMFT BSF
based on your holding the position until expiration.

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

CHAPTER 9

Binary Option
Behavior as
Expiration
Approaches

W ith regular put/call options, as expiration approaches, the time
value goes down. This is known as time decay. With binary op-
tions, as expiration approaches, you will start to notice a very in-
teresting phenomenon. This phenomenon occurs due to the binary nature
of these options. It also presents some interesting opportunities and should
be addressed, as it is a key attribute of binary options.

UNDERSTANDING DELTA

In order to illustrate this phenomenon, you must understand the concept
of delta. Delta is simply the amount that the price of the option changes for
every dollar that the price of the underlying changes. For example, with a
deep‐in‐the‐money option, the delta will be 1 to 1 since for every dollar that
the underlying grows, the option will also grow by $1.

If you have a deeply out‐of‐the‐money option, the option will have
a lower delta. This is due to the fact that as the underlying grows by $1,
the option does not become significantly more likely to be in‐the‐money.
Therefore, the $1 growth in the underlying will have only a minimal impact
on the price of the option.

As you will shortly see, the delta will behave significantly differently
with vanilla put/call options than with binary options.

To learn more about delta and other option parameters, you can visit
our companion site, www.traderschoiceu.com.

123

124 BINARY OPTIONS

Binary Option Vanilla Option

Profit Profit

Strike Price at Strike Price at
Price Expiration Price Expiration

Loss Maximum Risk = Premium Maximum Risk = Premium

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

EXHIBIT 9.1 P&L Graph of a Long Binary Option Next to a Vanilla Call Option

In Exhibit 9.1 a profit‐and‐loss (P&L) graph of a long binary option is
juxtaposed with a P&L graph of a vanilla call option. A vanilla option has a
smoother graph than a binary option.

To demonstrate this concept further, let’s once again use the same op-
tion chain that we have been using in the majority of the examples pro-
vided in this text.

12 Hours to Expiration Example

Exhibit 9.2 is an example of a US 500 binary option chain with 12 hours
until expiration.

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
Daily US 500 (Mar) > 1259 17 12.7
Daily US 500 (Mar) > 1256 26 20
Daily US 500 (Mar) > 1253 36.1 29
Daily US 500 (Mar) > 1250 48.1 40.1
Daily US 500 (Mar) > 1247 60.1 51.6
Daily US 500 (Mar) > 1244 71.2 63.1
Daily US 500 (Mar) > 1241 79.9 73.9
Daily US 500 (Mar) > 1238 87.4 83.4
Daily US 500 (Mar) > 1235 92.3 90.4
Daily US 500 (Mar) > 1232 95.4 95.3
98.4

12 hours to expiration, futures trading at 1250

EXHIBIT 9.2 A Binary Option Chain

Binary Option Behavior as Expiration Approaches 125

With traditional put/call options, the principle is simple: The closer you
get to being “in‐the‐money,” the higher the delta. Also, the closer you get to
expiration, the lower the delta becomes for each strike price.

Now let’s look at what happens with binary options around expiration
time:

Let’s assume that you purchased a “> 1250” at‐the‐money option when
the underlying was trading at 1250. Based on the option chain above, you
would have purchased that call for $51.6 per contract.

As expiration approaches, if the S&P 500 futures close above 1250,
your collateral investment of $51.6 will turn into $100. However, if the S&P
500 futures close at 1249.99 or below, your initial investment of $51.6 will
turn to $0.

Exhibit 9.3 demonstrates the price behavior of a binary option at ex-
piration. If at expiration the underlying is above the 1250 strike price, the
initial investment of $51.6 is in‐the‐money and worth $100. If at expiration
the underlying is below the 1250 strike price, the initial investment of $51.6
is out‐of‐the‐money and worth $0.

As you can see, this is a huge difference. A one‐cent move in the price
of the underlying right before expiration represents a difference of $100 in
the price of the option at expiration.

If there is still a lot of time before expiration, then a $1 move around
the “at‐the‐money” price point of the underlying is fairly insignificant since
there is still plenty of time for it to make a move in one direction or another
and still roughly a 50 percent chance that it will end up above or below the
at‐the‐money price.

However, as expiration approaches, the underlying has less time to
move in one direction or another. For this very reason, the premiums of
the options with strike prices around market price will have huge deltas, as
every dollar move can potentially make the difference between a $0 value
at expiration and a $100 value at expiration.

So now let’s look at the option chain again and make some assump-
tions about where the options premiums are likely to end up as expiration
approaches, based on these principles.

EXHIBIT 9.3 Depiction of Binary Option at Expiration

Binary Price S&P futures above 1250 S&P futures below
Option 1249.99

Long > 1250 $51.6 Initial investment grows to Initial investment turns
$100 to $0

126 BINARY OPTIONS

20 Minutes to Expiration Example

Exhibit 9.4 is an example of a US 500 binary option chain with 20 minutes
until expiration.

Assuming that the S&P futures remain at 1250 at expiration, here is
what the strike prices in the options chain are likely to do and why, as you
get within 10 to 20 minutes of expiration:

Strike prices of 1256 and up will all decrease at a very quick rate. This
is due to the fact that it is very unlikely for the S&P 500 futures to jump six
points in 10 to 20 minutes. No one wants to buy these options anymore.
And the traders holding these options are all trying to get rid of them to
at least salvage some of their investment. Therefore, because of the basic
rules of supply and demand, the price of these options will drop quickly.

Strike prices of 1244 and down will all head toward $100 at a very fast
rate. Once again, this is due to the fact that it is highly unlikely that the
S&P 500 futures will drop by six points in 10 to 20 minutes. All traders
will want these options since they are all highly likely to expire at $100.
Traders holding them may as well wait until expiration to get the full $100
return on their invested collateral. Further, anyone that was short will be
trying to buy the options back to at least salvage some of their investment.
So what’s happening is that no one is selling here and traders want to buy,
so the price naturally starts to move toward $100 very rapidly for these
options.

Contract Bid Offer
Daily US 500 (Mar) > 1268 - 3.0
Daily US 500 (Mar) > 1265 - 3.0
Daily US 500 (Mar) > 1262 - 7.0
Daily US 500 (Mar) > 1259 - 7.0
Daily US 500 (Mar) > 1256 - 7.0
Daily US 500 (Mar) > 1253
Daily US 500 (Mar) > 1250 54.00 55.00
Daily US 500 (Mar) > 1247 56.00 57.00
Daily US 500 (Mar) > 1244 70.00 71.00
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 -
97.00 -
-

20 Minutes to expiration, futures trading at 1250

EXHIBIT 9.4 A Binary Option Chain

Binary Option Behavior as Expiration Approaches 127

Now, as you look at strike prices close to the market price of the under-
lying (like 1253 and 1247), things get a bit interesting. The delta becomes
huge, as every dollar move represents the potential difference between a
$100 payout and a $0 payout for the trader at expiration.

For example, if the S&P futures are sitting right at 1250, as the market
approaches expiration, the 1253 strike price will start to head toward $0. How-
ever, every single one‐point move up will have a significant positive effect on
the premium of the > 1253 option. For example, the premium may be $20 when
the S&P futures are at 1250, and it may jump to $30 if the futures move to 1251,
since with every one‐point move in the direction of the strike price, the likeli-
hood of the underlying’s breaching it by expiration grows substantially.

If the S&P futures are sitting at 1250 and drop to 1248 with a short
amount of time until expiration, the “> 1247” option may also drop in price
significantly, since now there is a higher chance of the S&P futures drop-
ping below 1247, which would cause that option to settle at $0.

DELTA AND PRICE

To summarize, as expiration approaches, the delta (sensitivity to the move-
ment of the underlying) increases significantly with option strike prices
that are around the market price of the underlying.

Exhibit 9.5 depicts the reaction of price and delta for an option as expi-
ration approaches. Notice that the options farther away from market price
will be heading toward the expiration value points of $0 or $100 and will
not be very susceptible to the price movement of the underlying. However,
the options closer to the market price of the underlying will be much more
susceptible to the price movement of the underlying because there is a good
chance that they will be affected by the value of the underlying at expiration.

EXHIBIT 9.5 Relationship of Delta to Option Price

Above/Below Delta as Expiration Option Price

Strike Prices Market Price Approaches Direction

Strike prices close to market Above Grows Toward $0
price Shrinks Toward $0
Strike prices further from Above Grows Toward $100
market price Shrinks Toward $100
Strike prices close to market Below
price
Strike prices further from Below
market price

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

CHAPTER 10

Technical
Trading
Strategies with
Binary Options

T echnical analysis is the art of forecasting the future price of a trading
instrument based on historic price. Typically, technical traders use
price charts to conduct their analysis with the x‐axis being time and
the y‐axis being price. See Exhibit 10.1.

When trading an underlying instrument, you are typically trying to fore-
cast direction. One of the great aspects of option trading is that you don’t
necessarily have to forecast where an instrument will go, but you can sim-
ply forecast where it will not go.

Op:1,719.8, Hi:1,729.4, Lo:1,710.4, Cl:1,724.4

(c) Barchart.com 1,950.0
1,900.0
Sep 11 Oct Nov Dec Jan 12 1,850.0
1,800.0
EXHIBIT 10.1 Gold Daily OHLC Chart 1,750.0
1,724.4
1,700.0
1,650.0
1,600.0
1,550.0
1,500.0
Feb

129

130 BINARY OPTIONS

There are certain technical principles that focus on areas where an in-
strument will not go. Once again, with the use of options you can speculate
on such future conditions.

One of the great advantages of binary options is that you can speculate
on volatility without having to fear that you will lose more than you put
into the trade.

SUPPORT AND RESISTANCE

One of the most popular and simplistic technical trading methods is using
the theory of support and resistance. Support is a level that an underlying
asset has previously had difficulty penetrating to the downside. The theory
behind support areas on charts is that, typically, when price hits support, it
stops and then reverses direction, moving higher.

Resistance is the exact opposite. Resistance is a price level that an
underlying asset has had difficulty penetrating to the upside. The theory be-
hind resistance is that typically when price hits resistance, it stops and then
reverses direction, moving lower. Exhibit 10.2 is a diagram demonstrating
support and resistance.

Support:

Price went down to the support level,
attempted to move through it, and then

reversed direction.

Resistance:

Price went up to the resistance level,
attempted to move through it, and then

reversed direction.

EXHIBIT 10.2 Depiction of Support and Resistance

Support is a price level that an underlying asset has difficulty moving
below. The more times price bounces off a support level, the more significant
that level becomes. Resistance is the exact opposite. Resistance is a price
level that an underlying asset has difficulty moving above. The more times
price bounces off a resistance level, the more significant that level becomes.

If you see a support/resistance area on a chart and believe that it will
not be breached, you may be able to use binary options to speculate on this.

Let’s look at a basic example.

Technical Trading Strategies with Binary Options 131

Long Trade Forecasting Where Gold Will Not
Trade Based on Support
Let’s review the following trade example:

Rationale Gold futures are trading at 1610 and you notice a support
area at 1600 and decide to speculate that the price will not breach 1600 to
the downside.

Exhibit 10.3 depicts a price chart of gold futures. The x‐axis represents
time, and the y‐axis represents the price of the gold futures. The straight
line represents a strong support level at 1600. Support is a price level that
an underlying asset has difficulty moving below. In this example, price
reached 1600 multiple times but failed to go below 1600.

Price
1620

1615

1610

1605

1600

Support Level 1595
1590
Time

8am 9am 10am 11am 12pm 1pm 2pm 3pm 4pm 5pm

EXHIBIT 10.3 Gold Futures Price Chart Showing Support

Trade Entry You buy one contract of the 1599 option for $90. You put up
$90 as collateral for the trade.

Trade Outcome If you are correct and gold futures stay above the 1600
level, you will receive revenue of $100 at expiration for a $10 profit on your
$90 investment ($100 – $90).

If you hold until expiration and the price of the underlying closes be-
low 1599 at expiration, you will lose your entire collateral of $90.

You can, of course, get out of this trade earlier to cut your losses or
lock in a smaller profit.

Exhibit 10.4 depicts the profit and loss (P&L) of going long the 1599
binary option. The x‐axis represents the price of the underlying, and the
y‐axis represents the P&L.

132 BINARY OPTIONS

Profit 100 Long one contract of “> 1259” binary option
75
50 1599
binary option

25 Max Profit = $10 Price of
0 Underlying

(Gold futures)

–25

–50 Max Loss = $90 The light grey shaded area represents
the maximum loss for one contract.
–75 Market Price
Loss –100 (= 1610) The dark grey shaded area represents
the maximum profit for one contract.

EXHIBIT 10.4 P&L Graph of a Long Binary Option Trade

Summary Exhibit 10.5 contains all of the data points for this trade.
When an underlying asset becomes trapped between a heavy area of

support and a heavy area of resistance, it becomes range bound. Range
bound is also known as a consolidation, and in the simplest of terms it
means that the underlying asset has not moved more than a certain amount
in one direction or the other over a certain period of time.

EXHIBIT 10.5 Data Points for Long Binary Option Trade

Trade Figure Calculation

Underlying asset Gold futures Ask price × number of contracts
Market price 1610 = max loss
Expiration 1 day $90 × 1 = $90
Strike price 1599 Collateral = max loss
Long/Short Long (buy) ($100 – ask price) × number of
Size 1 contract contracts = max profit
Price Ask price of $90/contract ($100 – $90) × 1 =
Max loss $90 $10 × 1 = $10
Max profit / max loss = risk vs.
Collateral $90 reward
Max Profit $10 $10 / $90 = .11:1

Risk vs. reward .11:1

Technical Trading Strategies with Binary Options 133
Resistance

Support

EXHIBIT 10.6 Depiction of a Consolidation or a Range

When an underlying asset is range bound, we can use a short volatility
binary option strategy to capitalize on the theory that price will continue to
stay within the range of support and resistance. Exhibit 10.6 is a diagram
of a range-bound asset.

When an underlying asset has difficulty moving above a resistance
level and below a support level, it becomes caught in a range. When this
happens, you may want to speculate that the underlying asset will remain
within this range in the future.

Range Trade Example

Let’s review the following trade example:

Rationale Let’s assume that gold futures are trading at 1600 and you see
a top‐side resistance of 1610 and a bottom support at 1590. You believe that
gold futures will stay within this range.

Trade Entry You sell one contract of the 1610 option for $10, and you
purchase one contract of the 1590 option for $90. Your collateral is $90 for
the long leg of your trade (the option premium) and also $90 for the short
leg ($100 – option premium), for a total collateral of $180.

Trade Exit If at expiration the price of gold futures is between 1590 and
1610, then you will get a $100 settlement on both the short and long legs of
your trade. You will take in revenue of $200—$100 for each leg. Your profit
will be $20 ($200 revenue – $180 collateral).

If you are incorrect and one of the levels is breached prior to expira-
tion, then you will lose the collateral on that leg. So you will lose $90 on one
of the legs and make $10 on the other, for a net loss of $80.

Exhibit 10.7 depicts the P&L of going long the 1590 binary option and
short the 1610 binary option. The x‐axis represents the price of the underly-
ing, and the y‐axis represents the P&L.

134 BINARY OPTIONS

Short one contract of “> 1610” binary option and long one contract of “> 1590” binary option

Profit 100

75

50 1590 1610

binary option binary option

25

0 Potential Profit = $20 Price of
Underlying

–25 (Gold futures)

–50 loss = $90 loss = $90

–75 Market Price
Loss –100 (= 1600)

The light grey shaded area represents
the loss of one long contract and the
loss of one short contract.

The dark grey shaded area represents
the combined profit of one long contract
and one short contract.

EXHIBIT 10.7 P&L Graph of a Short Volatility Binary Option Trade

Summary Exhibit 10.8 contains all of the data points for this trade.

EXHIBIT 10.8 Data Points for Short Volatility Binary Option Trade

Trade Figure Calculation

Underlying asset Gold
Market price
Expiration 1600
Strike price long
Strike price short 1 day
Size long
Size short 1590
Price
1610
Total collateral
1 contract

1 contract

Long leg: Ask price of

$90/contract

Short Leg: Bid price of

$10/contract

$180 (Ask price + ($100 – bid price)) ×

number of contracts = total collateral

($90 + ($100 – $10)) × 1 =

($90 + $90) × 1 =

$180 × 1 = $180

(continued )

Technical Trading Strategies with Binary Options 135

EXHIBIT 10.8 (Continued)

Trade Figure Calculation

Max loss $80 Higher of:
(collateral of short position – profit of
Max profit $20 long position) × number of contracts =
Risk vs. reward .25:1 max loss
(($100 – $10) – ($100 – $90)) × 1 =
($90 – $10) × 1 =
$80 × 1 = $80
OR
(collateral of long position – profit of
short position) × number of contracts =
max loss
($90 – $10) × 1 = $80
Revenue – total collateral = max profit
$200 – $180 = $20
Max profit / max loss = risk vs. reward
$20 / $80 = .25:1

BREAKOUT TRADING

If a particular trading instrument has been trapped in a consolidation pat-
tern for a while, a technical trader may want to make an assumption that
it will break out either to the upside or the downside. One of the biggest
difficulties of breakout trading is that it is extremely hard to forecast the
direction of the breakout. In other words, you never know whether the
instrument will break out and go up or break out and go down.

Exhibit 10.9 illustrates a technical breakout to the upside. In this dia-
gram, the price of an underlying was caught in a tight range between sup-
port and resistance. Eventually, enough momentum occurred, causing the
price to push through the resistance level and climb higher.

Breakout
Resistance

Support
EXHIBIT 10.9 Technical Breakout to the Upside

136 BINARY OPTIONS

Exhibit 10.10 illustrates a technical breakout to the downside. In this
diagram, the price of an underlying was caught in a tight range between
support and resistance. Eventually, enough momentum occurred, causing
the price to push through the support level and move lower.

Resistance

Support

Breakout

EXHIBIT 10.10 Technical Breakout to the Downside

Fortunately, binary options offer you a way to take advantage of a
breakout without having to be concerned about the direction of the trade.
You can simply buy an option that speculates on the underlying’s going
up and sell an option that speculates on the underlying’s going down at
the same time.

As long as you buy the options relatively equidistant from the market
price of the underlying, if one of the options is correct, your profit on one
leg of the trade will be enough to overcome for the loss on the other leg and
yield a net profit. This type of trade is called a strangle.

Breakout Strangle Trade Example
Let’s review the following trade example:

Rationale Let’s assume that the Standard & Poor’s (S&P) futures are
trading at 1250 and they have been stuck in a range between 1240 and 1260.
You may decide that they are about to break out of this range but are not sure
about the direction.

Trade Entry You buy one contract of the “> 1260” option, and you sell
one contract of the “> 1240” option. Let’s assume that the price of the 1260
contract is $20 and the price of the 1240 contract is $80. In both cases, your
collateral is $20. So your total collateral is $40.

Trade Exit If the S&P futures stay within the range of 1240 to 1260, you
will lose your entire collateral of $40.

Technical Trading Strategies with Binary Options 137

Short one contract of “> 1240” binary option and long one contract of “> 1260” binary option

Profit 100 1240 1260
binary option binary option

75

50 Profit = $60
Profit = $60
Max loss = $40 Price of
25 Underlying
0 (S&P futures)

–25

–50 Market Price The light grey shaded area represents
(= 1250) the combined loss of one long contract
–75 and one short contract.
Loss –100
The dark grey shaded area represents
the profit of one long contract or one
short contract.

EXHIBIT 10.11 P&L Graph of a Long Volatility Binary Option Trade

If the S&P futures do indeed break out of the range and you hold until
expiration, the winning leg will give you revenue of $100, and the losing leg
will expire worthless. This will give you a profit of $100 minus your total
collateral of $40. This equals a $60 profit per contract.

Exhibit 10.11 depicts the P&L of going long the 1260 binary option and
short the 1240 binary option. The x‐axis represents the price of the underly-
ing, and the y‐axis represents the P&L.

Summary Exhibit 10.12 contains all of the data points for this trade.

EXHIBIT 10.12 Data Points for Long Volatility Binary Option Trade

Trade Figure Calculation

Underlying asset S&P futures
Market price 1250
Expiration 1 day
Strike price long 1260
Strike price short 1240
Size long 1 contract
Size short 1 contract
Price Long leg: Ask price of
$20/contract
Short leg: Bid price
$80/contract

(continued )

138 BINARY OPTIONS

EXHIBIT 10.12 (continued ) Calculation

Trade Figure (($100 – bid price) + ask price) ×
number of contracts = max loss
Max loss $40 (($100 – $80) + $20) × 1 =
($20 + $20) × 1 =
Total collateral $40 $40 × 1 = $40
Max profit $60 Collateral = max loss
$100 – total collateral = profit
Risk vs. reward 1.5:1 $100 – $40 = $60
Max profit / max loss = risk vs. reward
$60 / $40 = 1.5:1

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

CHAPTER 11

Fundamental
Trading

Strategies with
Binary Options

A s you may know, the central banks of various countries are always
releasing key economic data reports. These reports include unem-
ployment data, gross domestic product (GDP), interest rates, and
more.

NEWS RELEASES

Exhibit 11.1 depicts some relevant news releases and the effect they have
on the appropriate underlying asset.

EXHIBIT 11.1 Relevant News Releases and Their Effect on the Underlying Asset

Data Released Definition Underlying and Effect

Consumer Monthly; Change in the AUD/USD: Better than expected = bearish
credit EUR/USD: Better than expected = bearish
Released typically 37 total value of GBP/USD: Better than expected = bearish
by the U.S. USD/CAD: Better than expected = bullish
Federal days after outstanding USD/CHF: Better than expected = bullish
Reserve USD/JPY: Better than expected = bullish
the month consumer US 500: Better than expected = bullish

ends credit that (continued )

requires

installment

payments

139

140 BINARY OPTIONS

EXHIBIT 11.1 (Continued)

Data Released Definition Underlying and Effect

Unemploy- Weekly; The number AUD/USD: Better than expected = bearish

ment claims typically of individuals EUR/USD: Better than expected = bearish

Released 5 days who filed for GBP/USD: Better than expected = bearish

by the U.S. after the unemployment USD/CAD: Better than expected = bullish

Department week ends insurance for USD/CHF: Better than expected = bullish

of Labor the first time USD/JPY: Better than expected = bullish

during the US 500: Better than expected = bullish

past week

Federal Monthly; Difference in AUD/USD: Better than expected = bearish

budget typically value between EUR/USD: Better than expected = bearish

balance on the 8th the federal GBP/USD: Better than expected = bearish

Released business government’s USD/CAD: Better than expected = bullish

by the U.S. day after income and USD/CHF: Better than expected = bullish

Department the month spending USD/JPY: Better than expected = bullish

of Treasury ends during the US 500: Better than expected = bullish

previous month

Nonfarm First Friday Change in AUD/USD: Better than expected = bearish
payroll EUR/USD: Better than expected = bearish
Released of each the number GBP/USD: Better than expected = bearish
by the U.S. USD/CAD: Better than expected = bullish
Bureau of month of employed USD/CHF: Better than expected = bullish
Labor and USD/JPY: Better than expected = bullish
Statistics people during US 500: Better than expected = bullish

the previous

month,

excluding

the farming

industry and

government

jobs

Retail sales Monthly; Change in the AUD/USD: Better than expected = bearish
Released typically total value of EUR/USD: Better than expected = bearish
by the U.S. 14 days sales in the GBP/USD: Better than expected = bearish
Census after the retail sector USD/CAD: Better than expected = bullish
Bureau month USD/CHF: Better than expected = bullish
ends USD/JPY: Better than expected = bullish
US 500: Better than expected = bullish

Existing Monthly; Annualized AUD/USD: Better than expected = bearish
home sales typically
Released 20 days number of EUR/USD: Better than expected = bearish
by the U.S. after the
National month residential GBP/USD: Better than expected = bearish
Association ends
of Realtors buildings USD/CAD: Better than expected = bullish

that were USD/CHF: Better than expected = bullish

sold during USD/JPY: Better than expected = bullish

the previous US 500: Better than expected = bullish

month,

excluding new

construction

Data compiled from www.forexfactory.com.

Fundamental Trading Strategies with Binary Options 141

This table depicts several important data releases that impact various
underlying assets. These news releases have forecasts that economists
make prior to the data release.

Exhibit 11.2 is an example of an economic calendar.
If the actual data release is in line with the forecast, the markets will
remain fairly stable. However, if the actual news release deviates from the
forecast, the markets may move rather quickly and drastically.
For example, if the forecast for U.S. jobless claims is 350,000 and the
actual number comes up at 360,000, then you can expect that the U.S. dollar
will lose value relative to other currencies. This is due to the fact that the
jobless claims came out higher than expected, which is a negative sign for
the U.S. economy and thus the U.S. dollar.
Certain economic releases have more impact on the markets than oth-
ers. This is typically noted in an economic calendar. Economic releases
typically have a significant effect on the value of a country’s currency rela-
tive to other currencies.
If you believe that an economic event will have a significant impact on
a currency pair but are not sure of the direction, you may decide to enter a
long strangle (long volatility) trade. You can do this by buying a binary op-
tion with a strike price higher than market price and selling a binary option
with a strike price lower than the market price.

Strangle at News Example

Let’s review the following trade example:

Rationale The EUR/USD pair is trading at 1.3000 and the jobless claims re-
port is coming out. The forecast for the report is 350,000. You believe that once
the actual report comes out, it will have an impact on the EUR/USD cross.

Trade Entry Let’s assume that you can purchase a 1.3100 option for $20
and you can sell 1.2900 option for $80. Your total collateral for this trade
will be $40; $20 premium for the long trade and $100 minus the $80 pre-
mium for the short trade ($20).

Trade Exit If you are wrong and the EUR/USD pair stays within the
range at expiration, then you will lose your collateral on both legs of the
trade, for a loss of $40.

If you are correct and the EUR/USD pair closes above 1.3100 or below
1.2900 at expiration, then you will receive a $100 revenue settlement for the
winning leg, and your cash outflow is the total collateral of $40, for a total
profit of $60.

Especially for this trade, you may want to exit early if the price spikes
during the release and places one of your trades in‐the‐money. By doing so,
you may be able to lock in a profit due to a spike prior to expiration.

142 EXHIBIT 11.2 Example of an Economic Calendar

Feb 7 1:04pm Currency Impact Detail Actual Forecast Filter
12:00 1 JP 2 3 Leading Indicators 4 94.3% 93.9% Previous Chart
Date 2:45am EU French Trade Balance -5.0B -5.2B 93.7 5
3:00am CHF Foreign Currency Reserves 227.2B -4.1B
Tue 6:00am EUR German Industrial Production m/m -2.9% -0.1%
Feb 7 6:15am CHF Gov Board Member Jordan Speaks 254.3B
8:05am CAD Gov Council Member Macklem Speaks 0.0%
8:30am CAD Building Permits m/m
10:00am USD Fed Chairman Bernanke Testifies 11.1% 0.2% -2.6%
10:00am USD IBD/TIPP Economic Optimism 49.4
USD Consumer Credit m/m 48.1 47.5
3:00pm JPY Bank Lending y/y 7.7B 20.4B
6:50pm JPY Current Account 0.4%
6:50pm GBP BRC Shop Price Index y/y 0.63T 0.48T
7:01pm 1.7%

Economic Calendar provided by www.forexfactory.com.

1. This column shows the time a particular news release will be issued.
2. This column shows which underlying asset will be affected.
3. This column details the severity of the impact a news event will have on the underlying. Red means the data release may have a

large impact, orange means the data release may have a moderate impact, and yellow means the data release may have less of
an impact (color not shown in print book).
4. This column provides the name of the data release.
5. This column provides the actual numbers of the release, the forecasted numbers, and the previous report’s numbers.

Fundamental Trading Strategies with Binary Options 143

Short one contract of “> 1.2900” binary option and long one contract of “> 1.3100” binary option

Profit 100 1.2900 1.3100
75 binary option binary option

50 Max Loss = $40 Profit = $60
Profit = $60
Price of
25 Underlying
0 (forex futures)

–25 The light grey shaded area represents
the max loss of one long contract and
–50 one short contract.

–75 Market Price The dark grey shaded area represents
Loss –100 (= 1.3000) the profit of one long contract or one
short contract.

EXHIBIT 11.3 P&L Graph of a Long Volatility Binary Option Trade

For example, if the release is higher than expected, the EUR/USD pair
may shoot up. This will cause the “> 1.3100” to jump in price to $80. In this
case, you can simply get out and lock in your profit of $40 for the entire
long strangle.

One thing that you may want to consider is entering a take‐profit order
as soon as you get in on the trade. This way, as soon as a certain profit tar-
get of an option is hit, the entire long strangle will close and lock in a profit
for you. Of course, you can also exit this trade early to mitigate losses.

Exhibit 11.3 depicts the profit and loss (P&L) of going long the 1.3100
binary option and short the 1.2900 binary option. The x‐axis represents the
price of the underlying, and the y‐axis represents the profit and loss.

Summary Exhibit 11.4 contains all of the data points for this trade.

EXHIBIT 11.4 Data Points for Long Volatility Binary Option Trade

Trade Figure Calculation

Underlying asset EUR/USD
Market price 1.3000
Expiration 1 day
Strike price long 1.3100
Strike price short 1.2900
Size long 1 contract
Size short 1 contract

(continued )

144 BINARY OPTIONS

EXHIBIT 11.4 (Continued)

Trade Figure Calculation

Price Long leg: Ask price

Max loss of $20/contract
Short leg: Bid price
Total collateral
Max profit of $80/contract
Risk vs. reward
$40 (($100 – bid price) + ask price) × number
of contracts = max loss

(($100 – $80) + $20) × 1 = ($20 + $20)
×1=

$40 × 1 = $40

$40 Collateral = max loss

$60 $100 – total collateral = profit
$100 – $40 = $60

1.5:1 Max profit / max loss = risk vs. reward

$60 / $40 = 1.5:1

POLITICAL EVENTS

The markets are also always reacting to news that is related to political and
economic stability or instability. If you see that there is instability in certain
parts of the world, presidential elections, or new policy that may affect the
economy, you can implement binary options to take advantage of it.

For example, when a new president is elected, the market moves. If
you are not sure who will be elected and how the market will react, you
may decide to enter a long volatility strangle trade. This way, you don’t
have to forecast the direction of the market, just simply the fact that the
market will move. If you believe that a certain political event will not
cause a drastic move in the markets, you can take a short volatility stran-
gle trade.

Volatility Short Trade during Instability

Let’s review the following trade example:

Rationale Let’s assume that there is a key economic data release com-
ing out and you believe that it will not affect the Standard & Poor’s (S&P)
500 futures significantly. Because of the release, the option premiums are
up significantly.

The S&P futures are trading at 1250, and you are able to sell the 1310
option for $20 and buy the 1190 option for $80.

Fundamental Trading Strategies with Binary Options 145

Trade Entry You decide to sell the short strangle with one contract.
You sell the 1310 option and buy the 1190 option. Your collateral for the
1310 option will simply be $100 minus the premium of $20, and your col-
lateral for the 1190 option will be the premium of $80, for a total collateral
of $160.

Trade Exit If the underlying closes within the range of 1310 and 1190
regardless of the outcome of the data release, then you will receive $100
for each leg of the option, giving you a total profit of $40 (total settlement
$200 minus total collateral $160).

If the S&P futures do in fact end up moving significantly as a result of
the data release and close either above 1310 or below 1190, then you will
lose the collateral for one leg of your short strangle, but still keep the profit
on the other leg, since the S&P futures cannot be above 1310 and below
1190 at the same time at expiration.

Therefore, your revenue will now be only $100 for the winning leg, and
your outflow will be the total collateral of $160. This will give you a $60 net
loss on the trade if one of the strike prices is breached.

Exhibit 11.5 depicts the P&L of going long the 1190 binary option and
short the 1310 binary option. The x‐axis represents the price of the underly-
ing, and the y‐axis represents the P&L.

Short one contract of “> 1310” binary option and long one contract of “> 1190” binary option

Profit 100 1190 1310
75 binary option binary option
50
25 Max Profit = $40 Price of
0 loss = $60 Underlying
(S&P futures)
–25
–50 loss = $60

–75 Market Price The light grey shaded area represents
Loss –100 (= 1250) the loss of one long contract and one
short contract.

The dark grey shaded area represents
the combined profit of one long contract
or one short contract.

EXHIBIT 11.5 P&L Graph of a Short Volatility Binary Option Trade