The S&P 500 and other US stock indexes have been in a 1.5% range for over three weeks, as investors have digested earnings, economic data, and uncertain remarks from various Fed officials. While traditional traders wait for Fed Chair Janet Yellen's speech in Jackson Hole, Wyoming, this week, binary option traders have unique leverage to turn flat markets into outsized profits.
By Vikram Rangala
Thursday, August 25, 2016
Why are binary options uniquely suited to flat markets? Their all-or-nothing outcome at expiration means that even a small movement in the underlying market can result in a double- or even triple-digit reward for a small, defined risk.
Moreover, binary options let you trade the long and short side of the market's movements (however small) with equal ease. If you think a market that is dancing around sideways just below a particular price level is going to end the trading day below that level, you can sell a binary option with a strike price at that level. If you're right, you get the full $100 payout of the binary option.
That doesn't sound like much, but what if you had paid only $40 to sell it? Now your maximum risk is 40 and your maximum possible reward is 100, or more than double the return. And to get that return, all you need is for the market to stay below that line.
You don't need it to trend up or down a long way. In fact, the market may not move up or down more than a few points between the time you entered the trade and the time you exited (or the expiration time of the binary option).
A more than 100% return on a small market move is rare in most other markets. But it's the bread and butter of many binary option traders' strategies, something they trade day after day.
Look at the sidways movement of the US500 (the Nadex binary option based on the S&P 500) from August 19-24.
If you were a trend-follower, trading the SPDR® ETF or E-mini S&P 500® futures contract and decided to buy at around 2180, you might have managed, after a few days (and a weekend) of choppiness, to get some or all of the ten-point rally to just over 2190.
Of course, you would have had to set a wide stop-loss order to avoid getting stopped out, with a risk/reward ratio of something like 4 to 8—if you managed to time everything correctly.
During that same period, a binary option trader would have had multiple opportunities each day to take a smaller risk of a predefined amount for a greater percentage reward. Even if you lost on some of those trades, the losses would have been no more than you planned for.
And with binary options, you don't get stopped out, meaning that even if the market moves away from you and your binary goes to nearly zero value, you remain in the trade, ready to profit if and when the market comes back.
And all of this happens even if the market moves just one point, from below your strike price to above it (or vice versa). If you bought, for example, the August 19(4:15PM) US500 > 2181.0 binary option in the morning, for $20 or $30, it would have closed just a few ticks above 2181.0.
Those few ticks, or even just one, are all you need to get the full $100 payout. It's a different kind of leverage, one that works in the trader's favor. For a very small price change in the underlying market, you get an outsize return.
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