Due to the all-or-nothing nature of binary options, binary options provide market participants with a good way to trade in the direction of assets or the entire market. In addition to direct risk/return profiles and defined risks, they can also be used for short-term strategies due to hourly, daily or weekly contract expiration.
The payment of binary options depends on the result of a simple “yes or no” proposition, making them a clear and flexible trading tool.
- Binary can be used to make targeted bets, and can also be used to profit from horizontal markets or trade volatility.
- Because they are all-or-nothing binary options, they have almost no similarities with traditional options. They have different expenditures, costs and risks, as well as unique liquidity structures and investment processes.
- For our example, we will use the commonly used S&P 500 index binary options traded on the Nadex platform.
Directional Binary Options Strategy
For purely directional trading, let us take the US 500 Binary as an example.This is the contract provided by Nadex, it is E-mini S&P 500 Futures and use Nadex to calculate the last 25 futures transactions before the contract expires.
If you think that the E-Mini S&P 500 futures contract will hit a new high after breaking through the resistance level, you can buy the US 500 Binary to take advantage of your market view.
On the other hand, if you think that E-mini S&P 500 will not reach a certain price level target in the future; you can sell binary options higher than the target price in the same binary options.
For this targeted transaction example, let us assume the following:
- The trading price of the E-Mini S&P 500 futures contract is 2756.75
- Bullish E-Mini S&P 500 Index Futures, with a target price of 2770.00 at the end of the trading day
- The current time is 10:50 p.m. EDT
- The daily contract expires at 4:15 p.m. Eastern Standard Time
From the screenshots of the Nadex platform, there are four different execution prices. Their active market is lower than your target price of 2770.00 and expires at the end of the trading day. Compared with the basic market price and the binary execution price, each execution will have its unique risk/return profile.
Purchasing binary options at the offer price:
- US 500 (Sep)> 2760-cost 45 US dollars / potential profit 55 US dollars / 122% return on maturity
- US 500 (Sep)> 2763-Cost 34 USD / Potential Profit 66 USD / Yield to maturity 194%
- US 500 (Sep)> 2766-cost $27.75 / potential profit $72.25 / maturity return 260%
- US 500 (Sep)> 2769-Cost $21.50 / Potential profit $78.50 / Return on maturity 365%
Suppose you decide to buy US 500 (Sep)> 2763 at a price of 34.00 USD. All binary options contracts are settled at $0 or $100 when they expire. It is important to remember that binary options only need to account for 0.01% of the currency value to expire at 100. Therefore, basically, your US 500 (September)> 2763 contract needs to expire above 2763 to get the maximum payout of $100/contract. If the binary file expires at the strike price of 2762.00 or lower, your maximum loss will be your initial cost/contract of $34.00. (Note: These examples do not include exchange fees).
In this example, if the underlying market remains above 2763 at maturity, even if the bullish trend is not as expected, the contract will be settled at $100. Another important point to remember is that you will never commit to holding the position until the end Period when trading binary options. If you want to exit the transaction, you can take profit or stop loss in advance at any time before expiration.
When there may be significant risks in the direct transaction of the underlying market under volatile conditions, binary options can also be used as a tool for the volatility of the underlying market, but the risk exposure is limited.
With binary options, you can use the out-of-the-money strike price to buy or sell the market direction, that is, a cheaper initial cost. If the underlying market moves higher as expected and closes above the strike price (if you are the buyer), or if you are the seller, it is equal to or lower than the strike price, the contract value is $100. When trading the underlying market, there is no upper limit to the profit potential, but the dual choice provides a comfortable way to participate, with limited risks and potential positive returns.
Low volatility/stable market
If you think the market will remain stable and trade sideways, you can trade in-price binary files. Due to the capped payment structure at maturity, these binaries will have higher initial costs and lower returns. As long as the market remains stable, the binary options are already in the funds and you do not need to change them because the contract is worth $100 when it expires.
For example, if you paid $80 for a binary position, the net profit excluding transaction fees at maturity will be $20.
Traders can take advantage of binary options through a variety of strategies on the Nadex exchange. Nadex is a fully regulated U.S. exchange that provides currency pairs, stock indexes, energy, metals, agriculture and event contracts. These strategies involve risks and may not be suitable for all investors.