Binary Options Haruspex!
Binary options can be mathematical trivial and simple to use; binary options can be mathematically complex and simple to use What is not so simple to grasp is how they have been overlooked for so long.
All financial instruments from limit up, limit down futures, to convertible bonds, to conventional options can all be replicated exactly by structured binary options. Binary options can be construed as at the base of capital markets in the same way that 0s and 1s are at the route of all software languages.
As a greater understanding of these instruments develops they are sure to take on an ever-increasing role in all sectors of the capital markets.
Binary Option’s Past
If you read any of the pap concerning binary options on the internet you could be left with the erroneous impression that binary options are a new instrument invented Circa 2007. Binary options have in fact been around the capital markets for quite a while although confined primarily to the interbank FX market and, believe it or not, the base metals market.
Within the FX and metals market binary options come in the nomenclature of ‘all-or-nothing options’, ‘digital options’ and ‘barrier options’, the latter involving ‘knock-in’ and ‘knock-out’ options.
Knock-in and knock-out options involve some of the more mathematically complex pricing algorithms and the OTC FX market can safely be regarded as the most sophisticated capital market of them all.
Binary Options from 2007 to Today
Present day Tel Aviv can probably be considered as the internet marketing capital of the world. During the early ‘naughties’ Tel Aviv FX brokers started setting up shop, many with a Cypriot brass plate office, and brought a whole new game to the market for retail financial trading.
The same marketing juggernaut subsequently turned its attention to binary options creating the upsurge in interest as reflected by the below Google Trends graph showing keyword searches for ‘binary options’, ‘spreadbets’, ‘spread bets’, ‘spreadbetting’ and ‘spread betting’.
The interest generated in binary options has manifestly outstripped that of the spread betting market and is likely to continue to do so. A search on Google.com for the keyword ‘binary options’ reveals 21.4m results!
The New Instrument on the Block
The sophistication of the interbank FX market is in stark contrast to the other end of the binary options spectrum, as represented by the Over and Under strategies offered to the retail customer via the internet.
A binary call option is a bet that the price of an asset will be above a particular level (known as the strike) at a particular time in the future (known as the option expiry). An ‘Over’ is a binary call where the strike is the asset price at the time of the trade which means that if you believe in efficient market theory, the Over has a 50:50 chance of winning when the bet is placed. The breakeven payout is 100% so a winning £100 bet generates a $100 profit. The Under is betting that the asset price will be below the strike at expiry. They’re that simple!
It might be considered the Over and Under are equivalent to betting on Red or Black at roulette but they’re not since trading on markets is a game of skill, roulette is a game of chance.
Inspecting the Runes
So at one extreme the binary options spectrum contains knock-ins and –outs plus other mathematically complex instruments while at the other end Over and Under strategies require no mathematics at all.
At one end of the spectrum exist a highly sophisticated and professional market, at the other end amateur enthusiasts.
At one end of the spectrum the market can be valued in trillions while at the other just millions.
There is a veritable gap between the two markets and this gap presents a huge window of opportunity. It would be very difficult if not impossible for the interbank FX market to ‘dumb-down’ so the likelihood is that the gap will be closed by more sophisticated retail offerings.
In 2014 a new breed of binary options platforms will move into the retail space, platforms with a wider array of strategies, strategies incorporating proper risk management (not the dodgy asset price misrepresentation currently being passed off as risk management) and which will enable higher returns to be offered to the customers.
Binary options will be offered within various themes to cater for different interest groups such as sport, casino and the like.
Retail exchanges akin to Betfair and Nadex will sprout up around the world with professional binary options market-maker teams providing decent liquidity.
Mainstream exchanges such as the CME, Eurex, ICE will add binary options to their high profile products as opposed to dipping their toes in the water with the Vix……..
……….and at that point they will be the most popular and most heavily traded option in the world!