Monday, 25 January 2016

THE APPEAL OF BINARY OPTIONS

There is a type of option that is not offered by the "regular" options exchanges (such as CBOE or ISE). It's the binary option. 
Binary options are very easy to understand. The gambler (sure, there is an effort to describe players as stock-market investors, but trading binary options is gambling) places a bet. It works like this: Some future event will either be true or not true -- and you can take either side of that bet.
Another way to state the gambling proposition: Your wager will be worth $100 or $0 when the option expires. There are no other choices. If the event comes true, those who bet on "come true" can cash in their wager for $100. Those who bet it would not come true lost, and their "investment." is worth $0 (i.e., it expires worthless).
For example: "The S&P 500 Index will be up more than 6.00 points today." In the morning, before the market opens, let's assume that the futures markets are neutral. In that scenario, it is more likely than not that the proposition will turn out to be false because the index rises by more than 6 points less than half the time, or "not true" when the day ends. Thus, people who want to wager that the proposition will come true will get a little bit better than even money odds. Those who bet it will not be true must accept odds of less than even money (i.e., they can win less than $1 for each $1 wagered).
Binary options can also be used for longer-term situations, such as:
  • Donald Trump will be elected President of the USA in 2016
  • The stock market will close lower on Dec 31, 2016 that it did on Dec 31, 2015
  • Hillary Clinton will be elected president of the USA in 2016.
  • The Chicago Cubs will play in the World Series in 2016.
It's very easy to understand how binary options work. Most people like to predict things. When you have a strong hunch, it is tempting to place friendly bets with friends.
However, not everyone can do that and the binary marketplaces are happy to accommodate your needs.
One huge difficulty facing binary option traders is that the markets are not very fair. Bookies provide a better chance of earning a profit, even though betting with bookies is against the law. Bookies charge vigorish (the vig), or the percentage deducted from a gambler's winnings by the organizers of a game. Typically this is 10%. In other words, you must bet $100 to win $90. 
With binary markets, the bid/ask spread is very wide, and you will find that you often pay far more than 10% in vig. The numbers vary with the exchange and the type of wager. Read my review of one binary exchange.
It is important to note that it is sometimes impossible to exit a wager before the outcome is known. Some binary exchanges allow you to sell the call or put option that you bought, while others do not.
The market price of your wager (put option if bearish; call option if bullish) changes during the day because the stock market generally moves higher or lower. Looking at our earlier example,  "The S&P 500 Index will be up more than 6.00 points today," the bid price for the call option (i.e., betting that the statement will be true rises as the market rises. If the market is up 20 SPX points and the market will close in 10 minutes, then the proposition will almost certainly be true. In that case, there will be high bids (approximately 95 to 99) to buy the call, but there is unlikely to be anyone who would sell below 100.
Binary options have appeal because of their simplicity. Be certain that you understand the nuances before playing.

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