In a sports betting event the time of the event is fixed to a precise day and time. The 139th running of the Kentucky Derby starts at 6.24 pm at Churchill Downs. There is no choice for you to make, other than to decide whether to place a bet. The race ends at different times, depending on the speed of the runners.In fixed odds in the financial world, it is very different.
Here, you may have the opportunity to decide when the event starts depending on whether the broker offers this choice. If they do, you can decide to run your Kentucky Derby race at 6.24 pm, or 6.25 pm or whenever you choose. The choice is yours. The length of the event will then be precisely defined by the duration you select. But the key point is you choose when it starts.In binary options it is different again.
Here the start and finish time of the event are defined. The event starts at 6.24 pm and for a 15 minute event, finishes at 6.39 pm.But what does this mean from a betting or trading perspective?In the sports betting example, you have no choices to make other than selecting a runner. Imagine for a moment you believe your horse has a better chance of winning if the ground is wet. Can you change the date and time of the race to suit your horse?
The answer is no. You have to make a selection on the day of the race, and weigh up the odds.Moving to fixed odds trading. Does the choice of ground become an option? And the answer is yes. Why? Because now it is you who decides when the race starts. The broker is waiting for you to place a bet, but you decide when the race starts. This is an important aspect which we will cover in more detail as we move deeper into the subject, but it is a significant point, and one which is often lost in the betting/binary argument.
After all, if you are choosing when your event is run, is it possible to weight the probabilities in your favor? And when we are dealing with a financial instrument which has technical, fundamental and relational aspects, our understanding of how to forecast future price action using volume price analysis, will shift the probabilities in your favor. I explain volume price analysis later, and have written a separate book on the subject.Binary options differ again. Here we are presented with a menu card of events.
Each event on the menu has a specific start and end time. We cannot choose the start, but what we can choose is where we wish to join the race. This is equivalent to betting in running. Once in, we can also choose to leave the race if we wish.Whilst the event has a fixed end point, nevertheless we have the option to join at any time. This is an entirely different dynamic in terms of time.
Remember that probability and time are inextricably linked. In our horse racing event with our selection trailing along in last (and which we have backed to lose), we can then take advantage of the erosion of time and make it work in our favor, as there is little time left before the event finishes. The odds, or the probability of the horse winning would be low, allowing us to take a very low risk/low return bet. The binary option allows us to have time working for us, rather than against us. An issue we will explore further in more detail later.
It is important to appreciate at this stage, the erosion of time is not linear. This is a further aspect of binary options we will look at when considering price, and the underlying derivative. But for now let’s concentrate on time.As the event starts we have plenty of time left for our event to happen (or not). However, as the clock begins to tick down, the less time there is available for our event to occur.
And the closer we get towards the end of our event, then the wasting aspect of time increases exponentially. This is all shown in the simple schematic in Fig 2.10.Fig 2.10 – The effect of time on probability.As you can see this is not a linear effect. The Y axis represents the probability the event will happen. In other words the probability from 0% to 100%, and the X axis represents the time available for the event to happen (or not happen).
As the event starts, time has little impact at this point. Gradually as we approach the halfway stage of the event, time becomes increasingly important. Until in the last third of the event the erosion of time becomes exponential. As the event nears its conclusion, time is slipping away ever faster, with the probability of the event occurring becoming more or less likely.
This relationship speeds up continually, until finally the event ends.In some ways you can think of this as an old fashioned egg timer, but one with a hole that gets larger the longer the event. As it starts, there is plenty of sand still at the top of the timer, but as time wastes away so the hole in the middle becomes larger and larger allowing ever more sand to pass through increasingly quickly.