Serious traders and professional investment institutions alike are almost perpetually on the lookout for new methods of trading, and new investment tools that add flexibility to their portfolio. With the rise in online brokers and the increasing popularity of spread betting and other ‘out-of-the-box’ trading vehicles amongst consumer investors, a variety of alternative investment styles have sprung up to satisfy the demand for trading flexibility. One such style is known as binary betting, a fixed odd spread betting-like instrument.
Binary betting presents the trader with a binary option on a given market. The market will only move either up or down, and regardless of the extent of the movement in either direction, the trade presents an all or nothing outcome, awarded at either 100 or 0. In effect, this means the trader is essentially just backing the direction of the market, making no warranties on the volume of movement in a particular direction. Prices are quoted as spreads which represent fixed odds depending on the broker’s interpretation of likely market movements, and thus the spread represents the maximum profit and loss from the outset.
Here’s a working example: the binary betting market for the FTSE 100 is quoted with a spread of 48-51, the interval representing the broker’s commission portion on the transaction. If a trader thinks the FTSE will have a positive day, he could ‘buy the spread at 52 at a rate of £1 per point. If the market moves up by 1 point on the day, the trade will be closed at 100, representing a profit of £48 (100-52 x £1). If the market closes 1 point down on the day, the loss will be £52 (52-0 x £1).
Note that even if the market moves up or down by 20 points on the day, or even 200 points, the binary bet will deliver the same return. The trader is merely taking a position on the movement of the market.
Binary trading is a great way to quickly take a position on the direction of a market, with fixed odds and no need to worry about the subtleties of market pricing. Delivering much of the same benefits to traders as spread bets, including significant leverage, binary betting is becoming an increasingly more widespread and profitable trading vehicle.
Binary betting can at first seem like an alien concept, particularly for traders unfamiliar with spread betting and the concept of fixed odds. In actuality, it serves as an easier trading style than many others, insofar as understanding the ins and outs of the system are concerned. While the individual markets for binary bets vary depending on the broker you chose, the basic underlying principles remain the same.
Binary bets are quoted similarly to spread betting, which defines both the buy price, the sell price and the commission component taken by the broker. The outcome is then settled as either a win or a loss – numerically, that’s 100 or 0 respectively. If you buy a position and the market moves up, you win, whereas if the market falls, you lose.
Note that binary betting is not concerned with the volumes of movement in a market – it’s simply a bet on whether the market will move up or down. This makes it (theoretically) easier for the trader to call the outcome, and in essence, you can only ever be right or wrong – there’s no margin for a small gain or a massive loss.
Another example: a broker quotes spreads for binary bets on oil prices at 63-68. This represents a reasonable likelihood that the market will rise over the period, because the broker has effectively shortened the odds offered. The trader can buy at 68, and if the market rises, his profit portion is stake x (100-68). If the market falls, his loss is stake x 68.
This means there is a cap on the potential profits and losses that can be taken from a transaction. Unlike spread betting, where the extent of market swings represent greater returns (or losses), it is only the direction of movement that factors in to the equation when dealing in binary bets.
Regardless of the market the binary bets are offered on, the fundamental concept works the same – bets are settled at either 100 or 0, and are quoted on spreads that sit somewhere within that range, allowing the trader to capitalize on forecast market movements.
Binary betting can be a particularly effective strategy when implemented as part of a wider trading portfolio. The flexibility it provides allows traders to speculate on market movements, either as an addition to their other trading activities or as a hedge against wayward positions in other transactions. A cost effective, straightforward, tax-efficient trading style, binary betting can be an invaluable tool when implemented correctly.
One of the key ways in which binaries can be used to good effect as part of a trading portfolio is in hedging. Hedging is the process of taking two complimentary positions to offset losses in either, with the ideal outcome being to provide traders with a win in either direction or to mitigate losses if markets move against their positions. Because binaries can be processed to determine exactly the profit or loss that will arise, they are a great tool for hedging, and can factor in to the risk calculus to help minimize losses.
Suppose you are backing the FTSE 100 to move considerably up on the day, off the back of some strong results and a strong close in the US markets. Spread betting on the upward movement of the market could pave the way for significant gains, but if the market falters, you could end up losing an equally considerable amount.
The solution? To sell the FTSE in a binary. This could lead to a situation where a rising market will cancel out the losses on the binary position, whereas if the market unexpectedly fell, you would be able to offset much of those losses by the downside gain on the binary bet. Of course, it’s all dependent on the prices and the spreads offered, but opportunities like this are available to help minimize certain of the risks associated with trading.
It is also possible to use binary betting to capitalize on market movements over short periods of time, as a sort of ‘double up’ to other positions. If oil prices look set to rise on the day, a binary bet could be a good way to enhance profits over the short-term, even if you have larger positions outstanding in the market for a longer time-frame. Because binary betting only works on the direction of the market rather than the extent of any movement in your favour, this makes it the ideal tool for capitalize on forecast market directional movements over shorter time spans.
Binary betting can be used in a variety of ways to bolster a trading portfolio, and depending on your individual trading style you might be able to integrate binaries to a greater or lesser extent in your trading. Either way, it is important to be aware of binaries as a comparatively straightforward trading option, to help maximize gains on the upside offset losses from elsewhere.