The binary options one touch put is a plain barrier option where the underlying has to only trade at or below the strike price for the strategy to immediately settle at 100. So, in the example of Figure 1 the CME Copper has to move to 3.7000 or lower for the binary options one touch put to immediately be triggered and settle at 100 with immediate liquidation of the position.
The binary options one touch put is an American option as opposed to the European version of Binary Put Options. In options terminology, a European option can only be exercised at expiry while the American option can be exercised at any time up to and including expiry. Since there is absolutely no point in waiting until expiry to exercise a binary options one touch put then it is generally settled immediately.
Unlike the European binary put option, the binary options one touch put has no ambiguous area where the underlying settles exactly on the strike. In one touch terms this immediately defines the winning bet so that there is no ‘dead heat’ possibility, the option has just two settlement prices, 0 or 100. The expiry price profile is the same as Figure 1 of the Binary Put Option page but without the ‘dead heat’ settlement at 50.
This characteristic means that with the same strike, implied volatility and time to expiry a binary options one touch put will be twice the price of the European binary put option. Why? At the strike, the one-touch put will be worth 100, while the binary put option will be worth 50. At any time prior to expiry, there would be the possibility of locking in a profit by buying the binary put option twice and selling the one-touch put once if the binary put options were offered at less than 50, and vice versa.
Unfortunately, financial markets are never quite so easy to make money from since at the strike the one-touch put disappears having settled at 100, leaving the risk of having a binary put option to ‘leg out of’. Furthermore, there is an additional risk if the position is short two binary put options and long one binary options one touch put, and the underlying price barrels down through the strike with no chance of the short binary put options being closed out at 50, e.g. on ‘the open’ the underlying price might gap down through the strike and hence any ‘arbitrage profits’ turn into losses.
Figure 1 shows the binary options one touch put overtime for the CME Copper. Although the 25-day profile has a fairly mild gradient reflecting a low delta, the profile with just 0.2 days to expiry reveals extremely high gearing; in fact, this option and the binary option one touch cal have probably the highest gearing of any financial instrument.
Figure 2 details the effect of different implied volatilities on binary options one touch puts.
Yet again the profiles are fairly standard with the lower implied volatilities representing a lower probability of the strike being reached.
With both illustrations, it is evident that the risk reversal cannot take place where theta and vega change sign. For this reason, the one-touch put would be a far more efficient method of trading time decay and implied volatility although selling theta and volatility means immediate loss should the strike be hit. Therefore the seller of the binary options one touch put who wishes to take in time decay or wishes to short implied volatility needs to be fairly confident that the underlying price is unlikely to fall to the strike.
From a practical standpoint, if the CME offered these options there is likely to be considerable demand from the over-the-counter brigade who are pricing up and trading CME Copper barrier options for their clients. These barrier options may consist of knock-ins and knock-outs which are very popular in the OTC market so a liquid binary options one touch put and the call would be a very simple method of hedging away the position prior to the barrier being triggered.
Find more articles in my Binary Options Glossary.
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