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.