Binary Options: Strategies for Directional and Volatility Trading

268 Pages·2012·3.87 MB·English

by  Alex Nekritin

Binary
Options
Founded in 1807, John Wiley & Sons is the oldest independent publish-
ing company in the United States. With offices in North America, Europe,
Australia and Asia, Wiley is globally committed to developing and market-
ing print and electronic products and services for our customers’ profes-
sional and personal knowledge and understanding.
The Wiley Trading series features books by traders who have survived
the market’s ever changing temperament and have prospered—some by
reinventing systems, others by getting back to basics. Whether a novice
trader, professional or somewhere in-between, these books will provide
the advice and strategies needed to prosper today and well into the future.
For a list of available titles, visit our Web site at www.WileyFinance.com.
Binary
Options
Strategies for
Directional and
Volatility Trading
ALEX NEKRITIN
John Wiley & Sons, Inc.
Cover Design: John Wiley & Sons, Inc.
Cover Image: (c) Andy Hair/iStockphoto
Copyright © 2013 by Alex Nekritin. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted
in any form or by any means, electronic, mechanical, photocopying, recording, scanning,
or otherwise, except as permitted under Section 107 or 108 of the 1976 United States
Copyright Act, without either the prior written permission of the Publisher, or authorization
through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc.,
222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the Web
at www.copyright.com. Requests to the Publisher for permission should be addressed to
the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030,
[phone], fax [phone], or online at http://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their
best efforts in preparing this book, they make no representations or warranties with respect
to the accuracy or completeness of the contents of this book and specifically disclaim any
implied warranties of merchantability or fitness for a particular purpose. No warranty may
be created or extended by sales representatives or written sales materials. The advice and
strategies contained herein may not be suitable for your situation. You should consult with a
professional where appropriate. Neither the publisher nor author shall be liable for any loss
of profit or any other commercial damages, including but not limited to special, incidental,
consequential, or other damages.
For general information on our other products and services or for technical support, please
contact our Customer Care Department within the United States at (800)
762-2974, outside the United States at [phone] or fax [phone].
Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some
material included with standard print versions of this book may not be included in e-books or
in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the
version you purchased, you may download this material at http://booksupport.wiley.com. For
more information about Wiley products, visit www.wiley.com.
Library of Congress Cataloging-in-Publication Data:
Nekritin, Alex, 1980–
Binary options : strategies for directional and volatility trading / Alex Nekritin.
p. cm.—(Wiley trading series)
Includes index.
ISBN 978-1-118-40724-0 (cloth); ISBN 978-1-118-41777-5 (ebk);
ISBN 978-1-118-52868-6 (ebk); ISBN 978-1-118-42182-6 (ebk)
1. Options (Finance) 2. Futures. I. Title.
HG6024.A3N448 2013
332.64'53—dc23
2012032301
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
This book is dedicated to my parents, Nina and Boris Nekritin.
Thanks for all your unconditional love and support.
Without you, none of this would have been possible.
Contents
Foreword xi
Preface xiii
Acknowledgments xvii
PART I Introduction to Binary Options 1
CHAPTER 1 What Are Binary Options? 3
On What Asset Classes Are Binary Options Available? 3
Binary Options vs. CBOE (Vanilla) Put/Call Options 10
Advantages/Disadvantages of Binary Options 13
Reasons to Trade Binary Options 14
PART II Binary Options Theory 17
CHAPTER 2 What Does Binary Mean? 19
Components to a Binary Option 20
Long Trading 22
Short Trading 24
CHAPTER 3 Pricing 29
Strike Price 29
Time Value 30
Price as a Natural Market Consensus 32
Reading a Binary Option Chain 35
vii
viii CONTENTS
PART III Trading Binary Options 41
CHAPTER 4 Binary Options Contract Collateral 43
Margin and Debit Risk of Vanilla Options and Futures 43
Collateral Explained 44
Binary Options Expiration Values 44
Collateralizing a Long Trade 45
Collateralizing a Short Binary Options Trade 50
The Mechanics of a Binary Options Short Trade 50
CHAPTER 5 Settlement 59
Settlement on Binary Option Long Trades 59
Commissions and Fees 73
CHAPTER 6 Entering and Exiting Binary Option Trades 75
Reading Quotes 75
Reading an Order Ticket 76
Exiting Trades 78
Exiting Your Trade before Expiration 81
CHAPTER 7 Keys to Trading Binary Options
and More Examples 95
Gold Binary Examples 96
Copper Binary Examples 99
PART IV Binary Options Trading Strategies 105
CHAPTER 8 Volatility Trading Explained 107
Taking a Volatility Long Position (Buying Volatility) 108
Regulating Success Probability and Payout with Strike Prices 111
Taking a Volatility Short Position (Selling Volatility) 113
Regulating Range and Payout with Strike Prices 116
Max Loss, Collateral, and Max Profit Summary Table 120
Contents ix
CHAPTER 9 Binary Option Behavior as
Expiration Approaches 123
Understanding Delta 123
Delta and Price 127
CHAPTER 10 Technical Trading Strategies with
Binary Options 129
Support and Resistance 130
Breakout Trading 135
CHAPTER 11 Fundamental Trading Strategies
with Binary Options 139
News Releases 139
Political Events 144
Speculating on Actual News Releases 147
Economic Data Releases that You Can Speculate On 149
PART V Creating Your Binary Options Strategy 153
CHAPTER 12 Systems with Binary Options 155
Finding Your Edge 155
Proper Trading System Development 156
Back-Testing Binary Options Strategies 158
Three Back-Testing Rules 162
CHAPTER 13 Negative Emotions 165
Greed and Fear 166
How to Handle Negative Emotions 166
Find the Right System for You 168
Practical Steps to Mitigate the Negative Emotions 175
CHAPTER 14 Risk Management 183
The Process 184
Determining Position Size 185
x CONTENTS
Risk Management on Option Spreads 190
Relationship between Position Size and Trading Psychology 199
Handling Unexpected Market Volatility 199
Benefits of Binary Options on Trading Psychology 202
Discipline of Expiration 206
PART VI Managing Your Binary Options Account 209
CHAPTER 15 Proactive System Improvement 211
System Cutoffs 212
Drawdown 212
Consecutive Losing Trades 215
Reinvestment Rate 216
Diversification and Account Distribution 220
Intersystem Diversification 220
Account Breakdown 221
PART VII Profiting with Volatility 223
CHAPTER 16 The Volatility Short Trading Rules 225
Premium Collection 226
Rule 1: Cut Off Your Losing Trades 231
Rule 2: Collect Enough Premium 234
Rule 3: Sell Far Enough Away from Market Price 240
Rule 4: Use Underlying Instruments that Revert to the Mean 242
Rule 5: Sell Options with Proper Duration until Expiration 244
Rule 6: Perform Additional Analysis in Order to Get a
Feel for Market Direction 246
Rule 7: Attempt to Make Your Market 255
Conclusion 256
Glossary 259
Index 263
Foreword
B
inary options are a relatively new and unique way to take part in the
fi nancial markets. Over the past decade they have become popular
instruments in Europe and Asia, and more recently, over the past few
years, have not only gained acceptance, but have seen widespread growth
in the United States, particularly within the retail trading community.
One may ask, “Why, with all of the investment vehicles available,
stocks, futures, forex, options, exchange‐traded funds, and so on, would I
want to take a look at another contract type?” This is a legitimate question.
One of the main reasons traders may look to a contract like a binary
option is risk control. Any seasoned trader in any market knows that profi t-
ability on any given trade is secondary, but risk management on every trade
is mandatory and of the utmost concern. This is particularly true when par-
ticipating in leveraged markets such as futures and currencies, where one
mistake can not only result in large losses, but in some cases, losses that
exceed the amount of capital in the trader’s account. This can create an
ugly scenario for any trader—the dreaded margin call. If you’re not famil-
iar with this concept, just think of the reaction of Randolph and Mortimer
Duke at the end of the movie Trading Places and you may have a good idea
of the devastating effect a margin call can have.
I n the case of a binary option, whether I am buying or selling, my risk
is always limited and 100 percent defi ned up front, before the order is sub-
mitted. What this means is that a trader can very closely manage the risk
on every trade. No matter what happens in the world while the trade is
on—geopolitical tensions, central bank announcements, natural disasters,
whatever the case—the investor cannot lose more than is put up for the
trade. No worries of margin calls or being margined out, and more impor-
tantly, no chance of your broker calling you up and telling you that you
have to deposit more funds—funds that you may not have.
Another reason to consider binary options is simply cost. Many of you
reading this may have wanted to speculate in the fi nancial markets. You
may have been standing at the gas pump and thought, “I knew oil was go-
ing up.” Or perhaps you were reading the newspaper, saw something that
caught your eye, and said, “I think stocks are going up tomorrow.” Unfortu-
nately for many, the cost of placing a trade in the traditional markets may
xi