Use Binary Options to Trade Volatility

Use Binary Options to Trade Volatility


There are two types of volatility, historical and implied. Historical is simply the changes of the underlying asset’s price previously during a certain period. Implied volatility, then, is the market’s collective expectations about the performance of the asset in the future. A prudent trader is always aware of what the historical volatility has been and what the implied volatility is predicting the moves will be, as both of these factors are key to making the right decision on a binary options contract.

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The components used for an option’s pricing are the same in Binary options and classic options: market conditions of the underlying asset, the strike price of the option, volatility and time to expiry. Determining the price of a binary option is indeed the consensus of the market that there will be a certain outcome at a specific time. Pricing is highly affected by these important components, but let’s discuss the short-term opportunities that come with using binary options for trading volatility.

Using a flat market to your advantage with binary options

If you think that the underlying market will be still and/or will remain within a certain range, you can use binary options effectively to capitalize on your insight. The ITM (“In the Money”) binaries are the binary strikes to be considered, which means your initial cost is a larger portion of the maximum $100 expiration payout. Here, you are paying for the immediate advantage; higher probability of success = higher initial cost. This strategy allows you to buy or sell the binary option contract immediately which is in the money, or to create a combo trade where both legs would be ITM. In the latter case, if the market remains flat and finishes within the two strikes you will receive a double payout, but one binary leg will always finish in the money at expiration. As your binary is already in the money, you want the option to expire as quickly as possible; actually with binaries time decay works in your favor for ITM options.

How to trade binary options in a volatile market

If you believe that the underlying market will be volatile, and are prudent when it comes to trading in regards to the expected risk, then using binary options can be a useful tool to capitalize on your perspective. You would consider the OTM (“Out of the Money”) contracts, meaning that your initial cost is a much smaller portion of the maximum $100 expiration payout. As with the ITM binaries, the initial cost is related to the probability of success. This strategy allows you to either buy or sell the option immediately (directional trade) which is out of the money (OTM), or you can create a combo trade where both legs would be OTM.

There is a strategy that can be used to capitalize on this market scenario, which is buying high binary strikes and selling low strikes. Taking positions with cheap entry costs and making profits if the anticipated underlying market move is correct will come with a bigger percent payout.




Binary Options or Day Trading?


Binary Options or Day Trading?

It’s possible to make (or lose) money with by trading binary options or by day trading, and the two types of trading may appear similar on a superficial level, but there are some important differences between them.



Binary options overview

With a binary option, you either make a fixed profit or a fixed loss. Binary options can be available on different kinds of underlying assets, from stocks and commodities to major events such as jobless claims announcements. A binary option is about a yes/no question; traders are, in a sense, gambling on whether an asset’s value will be at or above a certain amount (the strike price) at a specified time (the expiry), or whether it will be below this amount.

The price at which you buy or sell a binary option contract is not the actual price of the underlying asset, but a value between zero and 100, depending on the probability of the asset’s value reaching the strike price. The trading range for a binary option contract will fluctuate throughout the day, but always settles at either 100 (if the answer is yes – the price is at or above the strike price) or zero (if the answer is no). The trader’s profit or loss is calculated by subtracting the price at which they bought the contract from the settlement price of zero or 100.

Day trading overview

In day trading, positions are opened and closed during the same session, which is not a fixed time period, although it is rare that a position is kept open overnight. Day traders buy and sell different kinds of financial instruments including stocks, commodities, forex currencies, etc. Day traders also attempt to predict the direction of the price movement of an asset, but their profits and losses are not fixed and depend on their entry and exit price, the size of the trade, the number of shares, and money management techniques such as stop loss and limit orders.

For example, a day trader might enter a trade and set a profit target of $100 and a stop loss of $25. Unless they put in a limit, they can let their profits run above $100 to fully benefit from a large price movement. If a day trader held onto a trade and didn’t put in a stop loss order, the loss on an unfavorable trade could quickly get out of control as the trader waits desperately for the price to move in the other direction.

How are they different?

In a nutshell, binary options allow traders to know in advance what their maximum profit could be and what their maximum risk is, while in day trading it is only possible to restrict trading outcomes by placing limit orders and stop loss orders. That is, if a day trader does not use proper money management techniques, both their potential profit and potential loss are entirely unknown and possibly limitless.

Binary options also have a fixed expiry date and time, while day traders have the option to close their position at any time or wait for a limit or stop loss to be triggered. The holder of a binary option also does not have the right to buy or sell the underlying asset, while the day trader does.