Binary options strategies for directional and volatility trading

PART III Trading Binary Options 41Margin and Debit Risk of Vanilla Options and Futures 43 CHAPTER 7 Keys to Trading Binary Options Taking a Volatility Long Position Buying Volatility 10

Binary Options

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Binary Options

Strategies for Directional and Volatility Trading

John Wiley & Sons, Inc

ALEX NEKRITIN

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.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted

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to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may

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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

Without you, none of this would have been possible

Foreword xi Preface xiii Acknowledgments xvii

On What Asset Classes Are Binary Options Available? 3 Binary Options vs CBOE (Vanilla) Put/Call Options 10

Contents

PART III Trading Binary Options 41

Margin and Debit Risk of Vanilla Options and Futures 43

CHAPTER 7 Keys to Trading Binary Options

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

Max Loss, Collateral, and Max Profit Summary Table 120

Contents ix

CHAPTER 9 Binary Option Behavior as

CHAPTER 10 Technical Trading Strategies with

CHAPTER 11 Fundamental Trading Strategies

Economic Data Releases that You Can Speculate On 149

Practical Steps to Mitigate the Negative Emotions 175

Risk Management on Option Spreads 190 Relationship between Position Size and Trading Psychology 199

Benefits of Binary Options on Trading Psychology 202

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

Conclusion 256

Glossary 259 Index 263

Binary options are a relatively new and unique way to take part in the

fi nancial 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 profi t-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 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

par-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 defi ned up front, before the order is mitted What this means is that a trader can very closely manage the risk

sub-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 fi nancial 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

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 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

en-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 CookSeptember 2012

Exchange‐traded binary options are fi xed‐risk/fi xed‐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 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 fi nd 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 benefi cial for beginner, intermediate, and advanced ers who are not familiar with binary options

If you are a beginner, all concepts are diligently explained, and you will

fi nd 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

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

PART 5: CREATING YOUR BINARY OPTIONS STRATEGY

Here, you will learn all about how binary options can be extremely 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

benefi-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

First 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 fi rst 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 fi ancée, Kendra, for helping me stay focused with her love and support

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P A R T I

Introduction to

Binary Options

Binary Options: Strategies for Directional and Volatility Trading Alex Nekritin

© 2013 Alex Nekritin Published 2013 by John Wiley & Sons, Inc.

.

C H A P T E R 1

What Are Binary Options?

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to the trader Commodity futures are exchange traded and typically change along with the price of the underlying

6 BINARY OPTIONS

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EXHIBIT 1.1 Advantages and Disadvantages of Binary Options

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

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10 BINARY OPTIONS

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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

There are two basic types of options: a call option and a put option

time before expiration

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EXHIBIT 1.3 P&L Graph of a Long Put

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ADVANTAGES/DISADVANTAGES OF BINARY OPTIONS

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a low minimum deposit Additionally, you can actually use binary options 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

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behavior of a binary option as it approaches expiration greatly differs from any other trading instrument If used properly, this behavior may

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expiration This allows you to place orders to enter and exit a given

EXHIBIT 1.4 Advantages and Disadvantages of Binary Options

$100 per contract Small contract sizes Market not as large as traditional options

market Potentially fewer strike prices available Easily available on multiple

instruments

More expiration times available

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relatively low investment

KEY POINTS: PART 1

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

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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

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Stock index futures

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Commodities futures

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Spot currency

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Economic data releases

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There are several advantages to trading binary options:

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Simple

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Intuitive pricing

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Trade multiple markets

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Unique price behavior at expiration

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Market open right up until the moment of expiration

Binary Options

Theory

This section will provide you with a basic understanding of how binary

option trades work

What You Will Learn:

Binary Options: Strategies for Directional and Volatility Trading Alex Nekritin

© 2013 Alex Nekritin Published 2013 by John Wiley & Sons, Inc.

.

C H A P T E R 2

What Does Binary Mean?

Binary options are considered binary because there are only two price of the underlying will either be trading above the strike price (true)

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COMPONENTS TO A BINARY OPTION

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sell) and ask (price to buy)

There are traders trading each of the strike prices for a particular

un-a long or short position

Expiration

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59.50 77.00 88.50 95.50 99.00 - - - -

- - - -

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500 500 500 500 500 50

500 500 500 500 50 50 50 50 50 50 50 50

02-DEC-11 02-DEC-11 02-DEC-11 02-DEC-11 02-DEC-11 02-DEC-11 02-DEC-11 02-DEC-11 02-DEC-11 02-DEC-11 02-DEC-11 02-DEC-11

22 BINARY OPTIONS

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LONG TRADING

Long In‐the‐Money

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whether it goes up or down as long as it does not drop below the strike price

and the light grey dashed line represents the binary option contract

Market price of S&P futures

Binary option with 1180 strike price 1185

Available

Strike Prices The binary option with a strike price of 1220 is above

the current price of the S&P futures and therefore

is considered “out-of-the-money” for a long trade.

"
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26 BINARY OPTIONS

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Market price of S&P futures

Binary option with 1180 strike price 1185

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contract

C H A P T E R 3

Pricing

Since a binary option can be settled at expiration only at $0 or $100,

the price of the option will fl uctuate between $0 and $100 until piration The price will fl uctuate 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 specifi c 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

Binary Options: Strategies for Directional and Volatility Trading Alex Nekritin

© 2013 Alex Nekritin Published 2013 by John Wiley & Sons, Inc.

.