Options’ trading has been around for decades, and many investors use numerous strategies to speculate on the direction of the financial markets. Unfortunately, the majority of the purchased options, either calls or puts, expire worthless. This is because the majority of the time, the premium that is paid, costs more than the actual move that occurs in an underlying asset. (An investor purchases a 100 Call on SPY for 4 dollars that expires in 30 days. Most of the time, the option will not move 4 dollars higher)
This situation is created because implied volatility, which is the perception of how much a market will move over the course of a period, is generally higher than historical volatility. In the chart above, implied volatility on the SPY ETF is higher than the actual historical volatility 95% of the time. Implied volatility is the greatest single input that affects the price of an option.
For investors who are looking to take directional bets on a financial instrument, one of the best ways to accomplish this, using options, is to trade binary options. Binary options, which are also known as “all or nothing” options, allow investors to speculate on the direction of a financial instrument, without paying a significant premium. Short-term binary options do not create a significant risk profile. when trading vanilla options. as the market rises or falls, a traders postion will become longer due to the underlying directional risk called the delta, as well as the volatility risk called the vega.
Call or Put binary options (which are also known as above or below options) are usually “at the money” and therefore just a small move will allow an investor to receive a payout. The payout profile for a vanilla option does not work the same way a binary option works, which makes small moves in the underlying asset somewhat insignificant. For example, if a trader where to purchase a SPY at the money call option that had 10 days left before expiration, when the market was trading 100, a move to 101 would only increase the price of the option slightly.
When trading binary options, the general payout is approximately 70-75% of the capital that is risked on a particular option. This allows investors the opportunity to make returns on very small moves. When there is a lot of volatility in the market, for example after an economic release, binary options prove to be very beneficial. There are also “one touch” binary options that allow a trader to receive a payout if the market touches a specific area. This can act as both a stop loss in the market or a way to take outright risk.
Hedging using binary options
Binary options can also allow an investor to hedge directional or portfolio exposure using a one-touch option. For example, if a trader was long the SPY, he could place a 1 touch put option below the market and receive a payout if the market moved to that specific level. The trader would lose on his underlying asset position, which would be offset by his gains on his one touch option.
Binary options are beneficial in many ways, but as a comparison to vanilla puts, they are a better pure play on directional risk. They provide investors the opportunity to speculate on the direction of a market, and receive a substantial payout immediately.