Binary Options Eachway Call definition and price profile
This post is published by Hamish Raw of https://hamishraw.com/
The binary options eachway call pays out for a win and a place. The binary options eachway call consists of two strikes so that at expiry, if the underlying is above the higher strike, the eachway call settles at 100. If the underlying is between the two strikes then the eachway call settles at 40, while if the underlying price is below the lower strike the binary options eachway call settles at zero. If the underlying price settled on either of the strikes then the mean of the adjacent settlement prices would be used for settling the strategy, i.e. 20 and 70 for the lower and higher strikes respectively. Therefore this particular binary options strategy is not an all-or-nothing bet but could be perceived as a strategy that pays out a secondary settlement price for ‘a place’.
In horseracing parlance, if the eachway call was offered at 25 and on winning returns 100, this would be equivalent to a 3/1 shot. A ‘placing’ of 40 is equivalent to a price of 40/25-1 = 0.6 which equates to 4/6 or 6/4 on.
The binary options eachway call provides a second bite at the cherry in the case where the speculator forecasts the market inexactly. In the example of Figure 1, maybe the exchange rate is moving upwards as forecast but not quite at the pace required to get it over the line for this strategy to settle at 100. The secondary settlement price provides the consolation of calling the market right but getting the momentum wrong.
Figure 2 provides the €/$ 1.29/1.31 eachway call over a range of time to expiry to illustrate how the price profiles behave over time. The 25-day profile possesses an extremely shallow gradient, thereby defining a very low delta, which is hardly conducive to a ‘get rich quick’ policy. Yet at the same time should this strategy be far enough out-of-the-money the premium will be little and the strategy would be a ‘sleeper’, one that the buyer can put in the draw and forget, while at the same time providing a very high percentage return, e.g. at the FX rate of 1.26 this strategy has a fair value of 9.1261 so would probably be offered at 10 by a market-maker. This would provide a minimum return of 300% above 1.29 and 900% above 1.31.
As time to expiry falls to the last day and less the profile slowly becomes steeper and only with 0.1-days to expiry does the profile resemble the settlement price profile of Figure 1.
Should the strategy be considered overly mundane then narrowing the space between the strikes will provide a more aggressive profile until the space between the strikes becomes nothing at which point the strategy is a straight binary call option. For example, Figure 2 becomes Figure 3 by halving the gap between the strikes.
This more aggressive strategy generates a higher binary options eachway call delta which of course is more conducive to the get rich quick mentality.
Figure 4 illustrates that with 5-days to expiry and strikes as far apart as two cents, changing the implied volatility does not have a great influence on the fair value of the eachway call, i.e. the eachway call vega would be fairly low at and between the strikes where the range of profiles lay close up next to each other.
Should the strikes be drawn closer, as in Figure 3, then the Euro/$US binary options eachway call price profiles of Figure 4 becomes Figure 5 where the profile could be mistaken for a binary call. As with conventional strangles, call spreads and put spreads, the binary options eachway call will have an optimum distance between the strikes which will generate the most interest from the punters.
The binary options eachway call of above is calculated as:
Binary Options Eachway Call = 0.4 x Lower Strike Binary Call + 0.6 x Upper Strike Binary Call
The ratio of 0.4 and 0.6 must sum to 1.0 although the ratios could be different, e.g. 0.25 and 0.75 which would also influence the attractiveness of the strategy. Applying the 0.25/0.75 ratio means a settlement price of just 25 between the strikes so that Figure 2 would thus become:
In conclusion, the binary options eachway call is likely to create a large following owing to the feature that the speculator can get close to being right, in reality losing the major prize, and still be rewarded with a runner-up spot.