Best Thread Binaries vs CFDs, Warrants, Spreadbetting, Options, etc.

[telcobert]

I have read up a bit about binaries. There remains however a BIG question about these, which seemingly nobody has asked before.

Why??

I mean there is a plethora of financial derivatives out there, with a enormous liquidity and market depth. For what reason would traders use binaries instead of those (or NOT use them, as the case may be... ;-) As a second question, would one do "pure play" trades in binaries or combine them with traditional derivatives?

Any thoughts on this - binaries fans or antagonists - from hands-on experience?

Tx, Bert

 

[HappyArber]

It's enjoyable.

 

[A Dashing Blade]

For what reason would traders use binaries instead of those (or NOT use them, as the case may be... ;-)

Binaries originally came out of the fx market in the late 80's iirc in response to either a) consumer demand or b) salesforce perceptions about their marketability (it's a chicken and egg argument really).

 

[NotQuiteRandom]

I like the volatility, the leverage and the fixed risk nature of the binary and other fixed odds financials.

I've traded everything going for many years and find them to be the best for several strategies. Obviously they don't replace the other instruments but they are a core part of my trading.

 

[Baldwreck]

For me its because I like short-dated options on indices (date to suit me) and not getting bounced out of positions through market spikes - also cannot be replicated in the real market elsewhere to the best of my knowledge - was once told on this forum that in fact it was easy to replicate (digital/fixed odds option) using Black-Scholes pricing model - but when I asked how, strangely there was no response. If any one knows any better I would be very pleased to hear from them!

 

[telcobert]

It's enjoyable.

Why so, HappyArber?

 

[telcobert]

- short-dated options - not getting bounced out - cannot be replicated -

Interesting points Baldwreck. On non-replication point: Is there a practical implication for that or are you making a theoretical point?

 

[telcobert]

- volatility - leverage - fixed risk nature - ...
Obviously they don't replace the other instruments but they are a core part of my trading.

Thanks for the list, Random.

One more thing: What do you mean by "core part" - percentage-wise? 10%? 25%? 50%?

 

[Baldwreck]

Interesting points Baldwreck. On non-replication point: Is there a practical implication for that or are you making a theoretical point?

Hi Telcobert

Practical - for example if I wanted to place a bet (trade) that the DAX closes above 7860 at close of business on 10th July; as far as I know I can only do that on Betonmarkets or Betsfortraders. Real options do not have the flexibilty on expiry dates that the digital providers offer as fas as I know.

Hope that helps.

 

[telcobert]

...that the DAX closes above 7860 at close of business on 10th July; ... Real options do not have the flexibilty on expiry dates that the digital providers offer as fas as I know.

There seem to be different elements in your answer: the fixed payment and more flexible expiries combined with more flexible strike prices. The last two I understand (apart from resulting worries about liquidity with so many possibilities ...) but not the first. Sure, "normal" options don't pay a fixed amount but offer a gradual payment scale. Now just to be sure: This would affect your trading strategy as you might miss the strike (e.g. the DAX cloing at 7860.97) and get nothing? Then it's not obvious how binaries would be always advantageous for the trader ...

Bert

 

[Baldwreck]

There seem to be different elements in your answer: the fixed payment and more flexible expiries combined with more flexible strike prices. The last two I understand (apart from resulting worries about liquidity with so many possibilities ...) but not the first. Sure, "normal" options don't pay a fixed amount but offer a gradual payment scale. Now just to be sure: This would affect your trading strategy as you might miss the strike (e.g. the DAX cloing at 7860.97) and get nothing? Then it's not obvious how binaries would be always advantageous for the trader ...

Bert

Yes Bert you are quite right - we are somewhat comparing apples and pears here. If it were possible to buy a DAX 7860 call option with a 10th July expiry then I would have no means of knowing what it would be worth at expiry (other than if the market ends below 7860 when of course its worthless), whereas a digital option wil be worth 0 or 1.

Because it is a live trade I will just update you on the current status.
I placed the bet on 27th June when the Dax was at 7796.75 - the bet was to win £70 gross if the index expired above 7860 on 10th July. The cost of the bet was £30.80 - as of a few minutes ago with the Dax at 7937.34 the bet is worth £41.30. However I always hold bets to expiry, so we shall just have to wait and see if this one works out.

For me the advantage is about certainty. If I'm wrong I lose £30.80 - if I win I'm £39.20 in profit.

On your last point, provided the Dax finishes at or above 7860.01 then BOM pay out.

Hope this clarifies.

 

[telcobert]

Holding binaries to expiry ... ?

However I always hold bets to expiry, so we shall just have to wait and see if this one works out.

Now that's an interesting one. Raises two more questions:

1. How many traders out there just wait for expiry vs netting early? Is liquidity so bad or what's going on?

2. On a hunch that many do just wait ... WHY would one hold to expiry even if one could salvage at least some cash from an out-of-the-money binary - or take a profit from an in-the-money binary if a market reversal is looming ... ?

Bert

 

[stevespray]

Now that's an interesting one. Raises two more questions:

1. How many traders out there just wait for expiry vs netting early? Is liquidity so bad or what's going on?

2. On a hunch that many do just wait ... WHY would one hold to expiry even if one could salvage at least some cash from an out-of-the-money binary - or take a profit from an in-the-money binary if a market reversal is looming ... ?

Bert

I think that you will find that the cost of trading in and out of these products is huge. Therefore, once you are in a position, it makes sense where ever possible to allow the bet to expire and therefore you effectively trade out of the position at the 'mid price' and therefore avoid the second part of the spread. At the end of the day, if you let a bet expire, you are only paying half the spread - that I guess is the answer to your question.

I played about with BoM some years back and found them to be extremely expensive. Traditional options strategies which took a day or so to move into profit with normal options would take the best part of a week on BoM (I'm taking about plays which would last 2 or 3 weeks) such was that size of their spreads. In my opinion, to make money on BoM in the longer term, you will need a considerable trading edge.

Steve.

 

[Baldwreck]

Bert & Steve
I agree with Steve's answer on why hold rather than cash early. Also my strategy is totally based on holding to expiry - using money managment to control risks/losses.

I also agree with Steve about BOM being expensive - trouble is they are the only game in town for some of their bets (though BFT now offer some competition). My guess is that competition will increase and BOM spreads will shrink.

IMHO it is possible to have a long term trading edge on BOM as I have a theory that short term options do not follow a Black-Scholes model.

I have been betting on BOM since mid 2003 and so far have had the following results.

2003 -1%
2004 +8%
2005 +57%
2006 +59%
2007 +65% to date

So there must be hope for everyone else!!

 

[stevespray]

Bladwreck... Impressive results over time - it looks like you have a clear edge. I'd agree with you with regard to short time frame options by the way. Any chance that you might outline your strategy?

With regrads to costs - I've just run two trades through the BoM quote engine whilst the Dax is pretty static.

Both bets to win £1,000....

Win £1,000 if Dax touches or trades through 8200 in the next 14 days = £629.03

Win £1,000 if Dax never touches or trades through 8200 in the next 14 days = £507.71

Total for both bets (ie 100% of outcomes covered) = £1,136.74 ... therefore the spread amounts to 13.67% (total round trip costs). That seems quite expensive but then I guess that these are classed as over the counter exotics so maybe it is par for the course. The fact remains however, even if you are very good / expert, you will need to be over 7% more efficient than the market just to make breakeven and that would involve you holding the contract until expiry.

Steve.

 

[Baldwreck]

Steve - firstly I agree with the generality of your analysis on BOM - my experience over my entire betting "career" with BOM is that I need a success rate of 56.5% to break even - so assuming the market is perfect at 50% as you point out one needs to outperform the market by (in my case) 6.5%. to stay afloat. My current succes rate over the entire period is 61.5% though as that has included the learning period I expect to be able to average 65% long term.

So Strategy - I do not believe in the perfect market. I have set out to develop an entirely mechanical system that was.

a) capable of being back tested over a very long period thus encapsulating most market conditions. So on Nasdaq FTSE Dow and S&P 500 I have backtested to 1985. The rest of the Europeans since early 90's.

b) was populated with sufficent data on the probability of an event happening so that the money managment system could also be back tested.

c) Had precisely know entry and exit points (obvious essential to validate the testing)

So the only bit that was missing was to understand the pricing and its only really been in the last few months of real trading (betting) that I think I have sufficient data to be confident on that.

Basically I subscibe to the general theory that markets move in waves determined by long term medium term and short term price influences together with price volatility. When all that lot is analysed together then whilst one cannot predict the direction of a market you can asceratin the probability of it moving in a certain direction in the short term - I generally place bets for two weeks.

A bit of a ramble but I hope that helps

 

[Baldwreck]

Now that's an interesting one. Raises two more questions:

1. How many traders out there just wait for expiry vs netting early? Is liquidity so bad or what's going on?

2. On a hunch that many do just wait ... WHY would one hold to expiry even if one could salvage at least some cash from an out-of-the-money binary - or take a profit from an in-the-money binary if a market reversal is looming ... ?

Bert

Bert
and another reason is - I'm not a screen watcher, neither time nor inclination nor temperment to watch the markets that closely - my view on binaries is that if you're not happy with your exposure you need to reduce the size of you bets.

 

[telcobert]

... the spread amounts to 13.67% (total round trip costs)...

Steve, that’s an amazingly simple yet powerful analysis with Baldweck's data supporting you number long-term.

This cost argument should not have surprised me as much as it did - I recall that ordinary high street bookies have a single round mark-up of 7-8% at least. At first sight, it is almost amazing that binaries are traded at all with such high cost.

On second thought it’s hard to consider this 13,67% round trip cost properly & fairly - given that a binary provides a much larger leverage than a traditional instrument, one would move far more volume with a binary. Fairest may be just to compare vs CFDs.

Still not easy. A CFD’s cost is an entirely different beast, depending on how long it is held and the volatility / margin consequences over this time to arrive at a kind of expected margin requirement against which to compare the spread. Actually find it hard to come up with a comparable number for CFD’s at all, as so much depends on these assumptions ... any better ideas?

BTW: With these economics we may well have reached at a key point of a comparison of Binaries vs. CFDs.

Bert

 

[Baldwreck]

Bert
Not too sure how one does the analysis but if its of any help here is some data from two live trades which I placed on BOM on 21st June which expired today.

1) Win £150 if CAC expires above 6093 on 4th July, cost £65.89 net winnings £84.91 bet taken out when CAC was at 6052.31 closing price 6098.08.
2) Win £60 if DAX expires above 8090 on 4th July, cost £27.62 net loss £27.62 bet taken out when DAX was at 8039.74. closing price 8075.26

So my maximum exposure was £93.51.

We know that CAC had an intraday low of 5897.8 during the period when the bet was live and that the DAX had an intraday low of 7750.62 during the period the bet was live.

If this had been say 50p a point spreadbet on both CAC and DAX then the exposure on the CAC would have been £77 and on the DAX £144.50 a total of £221.50. (ignoring spread)



So the spreadbetter has risked £221.50 to win £40.50, (ignoring cost of spreads)
Whereas the fixed odds punter has risked £93.51 to win £56.49.

I am sure it is possible to pick holes in the above argument, but for me its about risk control.

Lets hear some alternative views.

 

[telcobert]

I'm not a screen watcher, neither time nor inclination nor temperment to watch the markets that closely

So you are saying, you prefer binaries for their "automatic roundtrip" - i.e. expiry closes the position - would save not only the second spread but also time and nerves of a trader.

Now I agree. Nothing worse than worrying all the time. At a period when I traded FX I got really sucked into that 24 hours a day rythm and just could not switch off.

Is that what you are referring to?