Volatility Trading with Binary Options: How Does It Work


Volatility trading with binary options is like riding the big waves in the ocean of the stock market.

Binary options are a straightforward way of trading – you predict if a stock’s price will go up or down in a set time. However, volatility trading is all about how much those prices jump around. Let’s take a look at volatility in financial markets.

Most Important Facts About Volatility in Binary Options Trading:

  • Understanding volatility is crucial in binary options trading as it measures the magnitude and speed of price changes in financial markets
  • High volatility implies rapid and significant price movements, while low volatility suggests more stable prices
  • Traders employ various strategies tailored to different volatility levels, such as event-based trading, range trading, breakout trading, and news trading
  • The Volatility Index (VIX) measures market volatility expectations based on S&P 500 options prices, serving as a tool to gauge investor sentiment and market risk
  • Volatility directly affects the value of binary options, with higher volatility leading to increased option prices due to the greater likelihood of hitting the strike price before expiration

What Is Volatility in Financial Markets?

Volatility in financial markets refers to how much and quickly the prices of stocks, commodities, currencies, or other assets change over time. It is the speed and size of price movements.

In simple terms, if the price of a stock or asset jumps up and down a lot and very quickly, the market is said to be highly volatile. On the other hand, if prices change very little and slowly, the market is considered to have low volatility.

High volatility often means more risk because the prices are unpredictable, but it can also mean more profit opportunities if you guess the right direction of the price movement. 

Low volatility means less risk and potentially less reward since prices are not changing dramatically.

Understanding volatility is crucial for traders and investors, as it helps them decide where to invest and manage their risks.

Examples of Volatility

Volatility in financial markets can manifest in various ways. 

Here are some examples:

  • Earnings Reports

When a company releases its earnings report, it can significantly change its asset price. For instance, if a tech giant reports higher profits than expected, its asset price might increase. Conversely, the asset price could drop sharply if it declares a huge loss.

  • Economic News

News like changes in interest rates, employment data, or inflation reports can cause market-wide volatility. For example, if the Federal Reserve announces an interest rate hike, it might drop stock prices as borrowing becomes more expensive.

  • Global Events

Political events, like elections or geopolitical tensions, can also drive market volatility. For instance, U.K. and European markets experienced heightened volatility during the BREXIT negotiations due to uncertainty about the outcome.

  • Commodity Price Fluctuations

Commodities like oil can experience volatility based on supply and demand dynamics. For example, if OPEC decides to cut oil production, the oil price might spike due to anticipated supply shortages.

  • Pandemic Outbreaks

Unexpected global events like the COVID-19 pandemic can cause extreme volatility. During the early stages of the pandemic, global stock markets plunged due to uncertainty about the impact on the worldwide economy.

  • Sector-Specific News

News affecting specific industries can cause volatility in related stocks. For instance, a breakthrough in renewable energy technology might cause traditional energy stocks to fall and renewable energy stocks to rise.

  • Currency Markets

Currencies can be volatile in the foreign exchange market due to changes in a country’s economic outlook or interest rate differentials between countries.

Strategies for Binary Options Volatility Trading

  • Event-Based Trading

This strategy involves trading around major economic events or company announcements, which are likely to cause significant price movements. Traders must stay informed about upcoming events and understand their potential impact.

  • Range Trading

In range trading, you predict whether an asset will stay within a predetermined range. This strategy works well in markets with predictable, low volatility.

  • Breakout Trading

This is the opposite of range trading. You bet the price will move sharply in either direction, breaking past a set level. It is effective in periods of expected high volatility.

This strategy involves trading immediately after major news releases that are likely to significantly affect the market. Traders must be quick and informed about how news might affect asset prices.

Example Binary Trade with Volatility

Let us say a major Federal Reserve meeting is scheduled, and big news about interest rates is expected. This event will likely cause significant market movements, so you decide to trade a binary option based on it.

#1 Preparation

You check the ATR and Bollinger Bands for the asset you are interested in to understand current volatility levels.

#2 Trade Execution

After the interest rate announcement, you place a “high volatility” binary option trade, predicting that the price will rise or fall significantly but will move out of its current range.

#3 Outcome

The Federal Reserve announces a rate change, leading to a sharp price movement in the predicted direction. Your trade ends in profit since you bet on high volatility, and the price moves significantly.

Pros and Cons of Volatility Trading

Pros
  • High-profit potential
  • Opportunities in various market conditions
  • Excitement and engagement
  • Availability of advanced tools
  • Diverse trading strategies
Cons
  • High risk
  • Requires quick decision-making
  • Complexity
  • Potential for emotional trading
  • Overreliance on tools

Volatility Index Explained (VIX)

The Volatility Index, commonly known as the VIX, is an essential tool in financial markets. It is often referred to as the “fear gauge” or “fear index.” 

Here’s a straightforward explanation of what the VIX is and how it works:

What is the VIX?

The VIX index measures the stock market’s expectation of volatility over the next 30 days. It is based on options prices of the S&P 500 Index, a key benchmark for U.S. equities.

How Is It Calculated?

The VIX is calculated using the prices of a range of S&P 500 index options (both puts and calls), focusing on those near-term options that expire in the next 30 days. 

The calculation involves complex financial models that estimate how much investors expect stocks to fluctuate in the near future.

What Does the VIX Indicate?

A high VIX reading suggests that investors expect significant volatility, indicating uncertainty or fear in the market. A VIX above 30 is typically associated with high volatility and market turbulence.

A low VIX value indicates lower expected volatility, suggesting investor confidence or complacency. A VIX below 20 usually indicates a period of relative market stability.

Why Is It Called the ‘Fear Gauge’?

The VIX tends to spike during financial stress or market downturns when investors are fearful. Therefore, it is often seen as a barometer of investor sentiment, particularly their fears about future stock market volatility.

Uses of the VIX

It serves as a tool to gauge market risk, fear, and stress. Investors and traders watch the VIX to help make decisions about their portfolio allocations, especially when it comes to managing risk.

Some traders use the VIX for speculative purposes or as a hedging tool. Various financial products, such as VIX futures, options, and Exchange-Traded Products (ETPs), allow traders to bet on future movements.

Can You Trade the VIX with Binary Options?

Yes, you can trade the Volatility Index (VIX) with binary options, but it is important to understand how this works and what it entails.

Some binary options brokers offer the ability to trade on the movement of the VIX. This means you can bet on whether the VIX will rise or fall to a certain level within a specified timeframe.

Tutorial on Binary Options Volatility Trading

If you’re interested in trading binary options during high and low volatile periods, you may wonder how to get started. Trading during different volatilities requires various strategies to adapt to the circumstances.

This section will guide you through the beginning steps, ensuring you have a solid foundation before committing your investment capital. 

Pick a Suitable Broker That Does Not Avoid Trading During Volatility Times

First, you’ll want to select a broker that does not restrict trading during times of volatility because uninterrupted access to markets is crucial for seizing time-sensitive opportunities. This becomes more apparent when looking at the GameStop (GME) stock frenzy in early 2021. Brokers like Robinhood temporarily halted and restricted trading of GME, leaving many traders unable to capitalize on the rapid price movements.

Opting for a broker committed to continuous trading, even during periods of high volatility, ensures you can actively engage in trading and adapt to changing market conditions. Some of the top brokers for high volatility are  Pocket Option and Quotex, as they provide the best user experience with continuous trading.

Broker:
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Yield: 97%+
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2. Quotex
Yield: 95%+
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  • Min. deposit $10
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(Risk warning: Trading is risky)

Broker:
5/5
12345
Yield: 97%+
Advantages:
  • Welcomes International Clients
  • Offers High Payouts: 90% – 97%+
  • Professional-grade Platform
  • Swift Deposit Process
  • Enables Social Trading
  • Provides Free Bonus Incentives
The offer:

$ 5

Visit broker

(Risk warning: Trading is risky)

Broker:
5/5
12345
Yield: 95%+
Advantages:
  • Min. deposit $10
  • $10,000 Demo
  • Fast Execution
  • High Profit up to 95%
  • Fast Withdrawals
  • Free Signals
The offer:

$10

Visit broker

(Risk warning: Trading is risky)

Measure the Volatility

Measuring volatility in binary options trading is an important aspect of market analysis because it helps decide the degree of risk and which strategies to implement.

Volatility can be assessed through indicators such as Average True Range, Bollinger Bands, Volatility Index, and more.

Calculating historical volatility and monitoring potential volatility will contribute to a comprehensive understanding of the overall market. This helps predict how the value of an underlying asset will move. High volatility suggests larger price swings, while low volatility signals stable market conditions. By accurately assessing volatility, traders can adjust risk management, select appropriate expiry times, and utilize specific strategies.

Indicators for Volatility

Volatility indicators aggregate the data of past market movements, apply a formula, and display the results in a way that helps traders quickly understand how the value of an asset is expected to fluctuate. These indicators focus on the price action and disregard other information associated with the underlying asset. Instead, they analyze what has happened to an asset’s price historically and create predictions based on this information. Here are the top indicators for volatility:

Average True Range (ATR):

The Average True Range indicator is a fundamental tool for assessing market volatility. It calculates how far an average period of an asset has moved in the past. However, unlike other indicators, ATR is more precise because it factors in gaps in the market. Gaps are when the market jumps from one price to another rapidly. Other indicators use fixed formulas, and while that can be accurate, they do not account for gaps. 

ATR can help binary traders because it allows them to predict the range value of an asset. Without this prediction, only high and low options are available. For other binary option trade types, you have to predict the distance the value will move, and there is no better tool to utilize than the Average True Range.

Bollinger Bands

Bollinger Bands are effective for assessing volatility in binary options trading. These bands consist of a moving average and two standard deviation bands. During periods of high volatility, the bands expand, and during low volatility, they contract. Traders can observe the width of the bands to gauge the current level of market volatility and potential breakout opportunities.

When the Bollinger Bands tighten during low volatility, it raises the likelihood of sharp price movements in either direction. When the bands separate by an unusually large amount, it can indicate that any existing trend may end.

Volatility Index (VIX)

VIX measures the volatility expectations of the S&P 500. It showcases the implied volatility for the next 30 days. A decline in the VIX value indicates that the index is likely to be stable, whereas if the VIX value rises, it shows the S&P 500 is losing value.

Chaikin Volatility Indicator (CVI)

The Chaikin Volatility indicator helps understand how much an asset’s price fluctuates over time. It looks at the differences between the highest and lowest price points within a specific period. The result is then smoothed using exponential moving averages to provide more accurate data.

This indicator tells traders whether an asset is experiencing more price movement than usual or is relatively stable. When the indicator is high, it suggests the value is swinging a lot, showing high volatility. On the other hand, a low Chaikin Volatility reading implies less price movement, indicating lower volatility. Traders use CVI to identify trends, potential reversals, and how the market performs.

Binary Trading on Low Volatility

Binary trading with low-volatility assets requires specialized strategies adapted to the subtle price movements with reduced market activity. Here’s how you can approach binary options in a low-volatility environment.

Range-Bound Strategy

A range-bound strategy is well-suited for low-volatility trading, where the price of an asset tends to fluctuate within a specific boundary. The goal is to identify clear support and resistance levels, forming a range of the asset’s price. Traders using this strategy predict that the value of an asset will remain within this established range until the binary option expires.

  1. Asset Selection: Choose an asset known for stability during low volatility, like major currency pairs or commodities. This strategy is most effective when applied to assets with predictable price movements.
  2. Identify Key Levels: Use technical analysis tools to pinpoint support and resistance levels that define the price range. Look for periods where the asset’s value has historically consolidated, forming clear boundaries.
  3. Choose Longer Expiry Times: Select a timeframe running from a few hours to days so there is more than enough time for gradual price movements within the identified range. Assess the risk-reward ratio and create the trade size accordingly.
  4. Monitor and Adjust: Regularly monitor the price movements within the identified range. If market conditions change or unexpected events occur, be prepared to adjust your strategy accordingly. This may involve re-evaluating support and resistance levels or modifying your trading approach based on emerging trends.

Trend-Following Strategy

Low-volatility assets that gradually increase or decrease in price work well with the trend-following strategy. This approach identifies and leverages market trends, opting for call options in upward trends and put options for downward trends. Trend following is ideal for traders anticipating slow and steady price shifts.

  1. Asset Selection: Begin by selecting an asset that displays distinct trends during low volatility periods. Commodities like silver and currency pairs work well for this.
  2. Identify the Trend: Identify the trend using technical analysis tools such as moving averages or trendlines. Look for patterns indicating either an upward or downward asset value trajectory.
  3. Choose Options Based on Trend Direction: Place a call option if the trend is going upward or a put option if the trend brings the asset’s value down. The success of this strategy relies on the expectation that the recognized trend will persist despite the gradual nature of price movements.
  4. Execute the Trade With Appropriate Expiry Time: Align the binary option expiry time with the trend’s timeframe. Adjust the trade size based on your risk tolerance and execute the trade.

Reversal Strategy with Boundary Options

When the market is quiet and stable, a reversal strategy with boundary options can be a smart approach for binary options trading. This strategy requires identifying when an asset’s price seems stuck within a price range and predicting if it will break out of that range within a certain timeframe. 

  1. Asset Selection: Pick an asset exhibiting periods of low volatility between certain price points. 
  2. Identify Consolidation Phases: Identify where the asset’s price fluctuates using technical indicator tools. Bollinger Bands, support, and resistance with basic chart patterns can help. RSI and volume will also help spot potential breakouts or reversals. Look for instances where the market appears to be gathering momentum for a shift in price.
  3. Use Boundary Options: Opt for boundary binary options, which predict whether the price will breach a predefined upper or lower limit within the selected expiry time.
  4. Execute the Trade With Appropriate Expiry Time: Based on the analysis, set the expiry time to accommodate the expected timeframe for the price movement. Finally, allocate some of your funds to the trade and execute the order based on your risk tolerance.

Binary Trading on High Volatility

Trading with high-volatility assets can bring higher profit potential but significantly increases risk due to the market’s unstable nature. Consider following these strategies for binary options during periods of high volatility.

Breakout Strategy

The breakout strategy is great when an asset is prone to sudden and significant price movements. This strategy requires identifying key support or resistance levels and anticipating a breakout beyond these levels.

Traders capitalize on the momentum generated by the breakout, selecting call or put options based on the trend.

  1. Asset Selection and Identify Key Levels: Choose an asset experiencing high volatility. You can confirm the amount of volatility by using indicators like Bollinger Bands and the Average True Range. Then, pinpoint the support and resistance levels.
  2. Breakout Direction: Interpret the data and select the appropriate trade to make. A breach above resistance suggests an upward breakout (call option), while a break below support indicates a downward breakout (put option). 
  3. Expiry Time and Finalize the Binary Option: Choose an expiry time that aligns with the expected duration of the breakout. Lastly, establish a risk-reward ratio and allocate funds to the trade.

Straddle Strategy

When an asset is experiencing extreme volatility, the straddle strategy is the best approach. It involves simultaneously placing both a call and put option with the same strike price and expiry time. Regardless of trend direction, traders aim to profit via substantial price movement.

  1. Asset Selection and Identify Key Levels: Find and measure the volatility of an asset using indicators like ATR and Bollinger Bands. Assets sensitive to news trends and geopolitical events are great for this strategy.
  2. Choose Strike Price: Based on analysis, determine a strike price and expiry time for the put and call options. You’ll want to set the strike price at the current market price and the expiry time at the duration of the expected price movement.
  3. Complete the Trade: Execute the trade simultaneously with a call and put option. This straddle position allows the trader to profit from whichever direction the market ultimately moves.

Double Red (Option Scalping)

The Double Red or Option Scalping is designed specifically for high volatility, aiming to capitalize on sharp and sudden price movements. With this strategy, you must identify short-term downward trends and execute trades accordingly. However, option scalping is high risk compared to other strategies.

  1. Asset Selection and Confirming Volatility: Verify the asset is experiencing significant volatility because this strategy thrives on sudden price movements. Utilize indicators that provide insights into an asset’s price fluctuations. 
  2. Identify Double Reds: A double red indicator comprises two successive red candles where the second candle closes at a lower level than the first. The proper configuration is when the second red candle is lower than the bottom shadow of the first candle. 
  3. Expiry Time: Once you spot the double red candles, set a put trade with an expiration time between 5 and 15 minutes. 
  4. Assess Risk and Trade: These binary options will have better payouts, but the risk is significantly higher, so allocate funds to the trade accordingly. Finally, complete the short-term trade.

Pros and Cons of High Volatility in Binary Trading

Pros

  • Potential for Higher Profits: High volatility often leads to larger price swings, presenting opportunities for substantial profits.
  • Bigger Payouts with High Volatility Strategies: Short-term binary options have higher volatility but are compensated with bigger percentage payouts based on the risk.
  • More Trading Opportunities: Traders can find numerous entry and exit points in a volatile market, allowing for more frequent trades.
  • Market Liquidity: Volatile markets often show higher liquidity, allowing traders to enter and exit positions easily.
  • Adaptive Strategies: Investors can utilize several binary options trading strategies to mitigate risk and adapt to high-volatility market conditions. 

Cons

  • Increased Risk of Significant Losses: Rapid and unpredictable market movements make binary options risky during volatile periods, and losses can compound quickly.
  • Requires Quick Decision-Making: Traders must make fast decisions based on the data provided to capitalize on short-lived opportunities. This increases the likelihood of making mistakes and losing trades if the information is interpreted incorrectly. Also, even if the correct choice is made, the volatile state of the market can quickly swing negatively.
  • Challenging for Beginners: High volatility can be overwhelming for novice traders because of the data needed to be processed and the fast-paced nature of the market. Also, the lack of experience increases the odds of making mistakes that lead to losses.
  • Unpredictability: Despite analysis and the use of indicators, high volatility inherently brings an element of unpredictability. There’s no guarantee the market will continue its trend, and prices can swing instantly.
  • Emotional Trading: Due to the highly volatile state of the asset, you may end up on a trading losing streak, which can cause emotional trading. This is where you stop trading based on the information provided but rather on emotions as you try to recoup losses.

Pros and Cons of Low Volatility in Binary Trading

Pros

  • Stable Market Conditions: Low volatility implies relatively stable price movements, making predicting the outcome of trades easier.
  • Easier for Beginners: Low volatility markets may be more forgiving for novice traders, allowing them to grasp the basics of binary options trading with less risk associated.
  • Focus on Fundamental Analysis: Low-volatility assets allow greater emphasis on analysts as market movements are less influenced by sudden external factors.
  • Consistent Trends: Trends in low-volatility markets tend to be more consistent with smaller price swings. This lets traders capitalize on the asset for extended periods as the price movement is easier to predict. 
  • Lower Dependency on Timing: Success in low-volatility trading depends less on precise timing than on highly volatile assets. This removes the urgency and provides more time for strategic decision-making.

Cons

  • Less Profit: Due to the reduced risk, low-volatility trading may result in lower payouts.
  • Slower Market Activity: Low volatility markets can exhibit slower trading activity, requiring patience from traders for significant market shifts.
  • Smaller price Swings: Limited price swings may make capitalizing on significant market movements challenging, especially for short-term trading.
  • Lower Liquidity: Low volatility assets may have reduced liquidity, potentially causing delays in executing trades. This is a huge negative for those looking to open large trade orders.
  • Risk of Trend Reversals: While trends in low-volatility markets may be more consistent, there is a risk of the market shifting to higher volatility. This could catch traders off guard and almost instantly make their trades lose.

How Does Volatility Affect the Price of a Binary Option?

The level of market volatility directly influences the value of binary options. When high volatility is high, the underlying asset has greater potential for significant price movements.

This increased likelihood of the asset hitting the option’s strike price before expiration makes the option more valuable. As a result, higher volatility leads to high binary option prices.

Moreover, implied volatility measures expected future price swings, a key factor affecting binary options pricing. An increase in implied volatility generally results in higher option premiums, while a decrease leads to lower premiums.

Conclusion

To summarize, we’ve provided a comprehensive overview of how to use volatility to trade binary options. Now that you know the best volatility indicators that provide insights into how an asset is performing, you can incorporate them when implementing a trading strategy. Also, we’ve discussed the best strategies advanced traders use, which you can utilize yourself. 

Always assess the risk factor and base your trades on technical analysis. Doing so improves your chances of accurately predicting the price movements and increases the likelihood of successful trades.

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Most Asked Questions:

Why is measuring volatility important in binary options?

Measuring volatility helps assess the level of risk and predict how the market will move. It provides insights into how an asset can perform in the future, which allows traders to use specific strategies.

Which indicators are useful for measuring volatility in binary options?

The best indicators for measuring volatility are Average True Range, Bollinger Bands, Volatility Index, and Chaikin Volatility Indicator.

Why is it essential to pick a suitable broker for trading during volatility?

Signing up to a broker that does not avoid trading during volatile periods allows uninterrupted access to markets. This ensures traders can capitalize on opportunities without restrictions.

Are there specific assets more prone to volatility in binary options?

Yes, certain assets, such as cryptocurrencies and stocks, are more prone to volatility. News, economic, and geopolitical events can usually severely influence prices, giving binary option traders opportunities to capitalize.

What role does implied volatility play in binary options pricing?

Implied volatility shows market expectations of future price swings, directly impacting binary options pricing. An increase in implied volatility leads to higher premiums, while decreased volatility results in lower premiums.

How does the Volatility Index (VIX) function, and what role does it play in volatility trading?

The Volatility Index (VIX) is a crucial tool for traders, providing insights into market volatility expectations. By understanding its calculation, significance as a “fear gauge,” and practical applications, traders can make informed decisions to navigate volatility trading effectively and mitigate risks.

About the author

Marc Van Sittert
Marc Van Sittert is an experienced Binary Options Trader and coach who is originally from South Africa. He started his career in 2014 by trading old-school Binary Options online. His main focus is on short-term contracts with 60-second trades.

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