Let me start by outlining what I believe constitutes an on exchange binary option, which will then lay the framework for the remainder of the book. There are four basic characteristics I consider to be essential and these are as follows:A binary option is quoted between 0 and 100.A binary option can be closed at any time.The quote has multiple strike prices .
Returns, as a percentage are not capped. If we start with the quotation first, a binary option will have two numbers quoted between 0 and 100. Just like the fixed odds proposition, the binary option can only have two possible outcomes.If it happens the binary option will close at 100, but if it does not the binary option will close at 0. There are only ever two possible outcomes, and much like the fixed odds trade, you either win or lose.
Furthermore, like the fixed odds trade, your maximum loss on any position is known in advance, as is your maximum profit. But notice I have not used the word fixed, and this is one of the key differences between a binary option and a fixed odds trade.This difference stems from the fact you can close out any binary option position early either to reduce the maximum loss or to take some profit off the table.
This is a key feature of a binary option, namely the ability to close out the position at any time during the life of the contract, and is one we are going to explore in a great deal more detail.What is perhaps less obvious, is this in effect means you are in control of your percentage returns and these are no longer dictated to you by the broker. You set your own odds if you like and trade accordingly.
In some ways, you can think of this as you being your own bookmaker. You decide on the odds, and then enter a position accordingly based on your own analysis of the market. This is a radically different proposition to the fixed odds trade. In addition, and perhaps more powerfully, you decide when to close the position. You do not have to wait for the end of the race, or in the option world what is called expiry.
If you have decided on a target, which is subsequently achieved before expiry of the binary options contract, you simply close out and take your profit. You could of course decide to stay in for a further gain, or close out to minimize any loss.Whatever your decision the key point is this. It is you who are in control at all times. You set the odds, you decide on your risk and reward profile, you decide when to close, and it is you who manages and controls your percentage returns.
You can even decide what price you want to enter and exit the market. On exchange binary options have been designed for you, not for the broker. The on exchange binary options broker is simply there to provide the instruments and trading environment to give you this control. This is what Nadex offer.I am going to explain all of these fundamental principles in greater detail.
You will then start to appreciate why the fixed odds product is a good starting point, and a stepping stone into binary options themselves. I will also cover the maths later in the book as we consider break-even ratios and profit margins as these apply to you either as a fixed odds trader or a binary options trader.
If we start with the binary option quote itself, the easiest way to think of this is in terms of probability, and perhaps take the simplest example of the probability of an event happening or not such as the toss of a coin. There is a 50% probability of a head or a tail, and this would be quoted as 50/50 from which we would know immediately the probability of either event occurring was equal.
And so it is when we look at the binary option quote. Indeed when considering binary options and their notation, we can instantly think of price reflecting probability.In other words, it is the market’s expectation of an event happening or not happening. As you will discover shortly, time has a huge impact on this simple statement.
Therefore, let’s start with a simple example, before gradually bringing in the other elements to build the complete picture.Suppose we see a binary option being quoted as 22/26 for an event occurring or not occurring. What is this binary quote telling us? If we take the mid point of these two figures at 24, this binary option is saying the probability of this event occurring is low.
Why? Because the probability being quoted is 24% of the event happening. The converse, is there is a 76% probability the event will not happen, since the sum of two mutually exclusive events must always equal 100. In this case it’s 100 – 76 = 24. This is the basis of the binary option quotation. What you are seeing in a binary quote is the market’s expectation of the event happening or not happening, at a particular moment in time.