Odds & Probabilities-Selling Put Options

In the first chapter we explored the sports betting world, and the reason for this is simple. Many of the recent innovations in sports betting are now being adopted in the financial trading world, under the umbrella term of binary, and in understanding the sports betting approach, I believe will help you to understand the world of binaries.

This catch all term is now being applied to all and every instrument, as traders and speculators rush to embrace this new approach to trading. At this point I think it would be useful if I lay out what I believe are the core differences between a binary option and a fixed odds bet. You may disagree with what I believe these differences to be, and you may even think this is merely semantic, which could also be true.

However, the fact remains this is a very grey area, and all I am trying to do here, before we delve into the platforms, quotes, odds and probabilities, is to lay down some definitions of what I believe are the differentials. Binary Options vs Fixed Odds:Let me first start by trying to compare these two terms, which I hope will help to clarify the remainder of this chapter. In chapter one we have already seen the following statements are always true, for each instrument:Your risk is always limited and can never be exceeded:Your profit is always limited and can never be exceeded:Now let’s look at those areas which are not common to each:

A binary option is quoted in probabilities whilst a fixed odds trade is generally quoted in cash or a percentage cash return A binary option can be closed at any time during the event a fixed odds trade generally cannot And this, in simple terms is what I believe distinguishes a binary option from a fixed odds trade. This is important as you will see in the following and subsequent chapters.But before we start to consider some actual examples, let me highlight the one principle which differentiates binaries and fixed odds from every other form of trading or investing. And that single principle is time. I touched on this concept in chapter one, but now I want to explain it in more detail here.

The Significance Of Time:In the world of options, whether binary or otherwise, and even in the context of betting, time plays a pivotal role. Time can be either your friend or your enemy, and whether it is working for you or against you will ultimately depend on how you have positioned yourself in the market.As the event nears its natural conclusion time slips away ever faster. And this is what I meant by the game changer I referred to in chapter one. It is a game changer for three reasons.First, what we are trying to forecast is not if an event will happen, but also to forecast within what timeframe this event will occur.

This is very different to all other forms of trading and investing, and which is why options, in the purest sense, are wasting assets. Options can and do expire worthless, a concept many traders struggle to grasp. After all, why would we want to buy anything which can and does go to zero? And it is time which creates this wasting effect.Second, in introducing the time element into the probability of an event occurring or not, the wasting aspect of time is reflected in the probabilities. This is perhaps self evident once we start to think of this in terms of a horse race again.

Third and finally, as the event nears its conclusion, time has a dramatic effect on the probabilities quoted. Again, this is perhaps self evident. After all, if the event is almost at an end and our selection can either win or lose, the yes/no probability will swing wildly. The same principle applies whether this is a horse race or a binary option in the financial world.If we take a horse race as our simple example. Suppose our horse is last in a big field of runners, with only a furlong left to run, and we have bet on our horse to win.

The probabilities of our horse suddenly surging from last to first and winning the race would be very low indeed. However, consider another race with perhaps 100 yards to run. And here our horse is second or third, with all three horses now neck and neck in the race to the line. The probability of a win would now be very high, but one which would also be swinging wildly as there are only two possible outcomes.

Either the horse wins or it does not win. With every stride nearer the finish line, the probabilities would be changing, and changing very quickly. Until perhaps the final few strides where you might see the probabilities swing dramatically from a very high probability, to a very low probability in a matter of seconds.