Binary betting can at first seem like an alien concept, particularly for traders unfamiliar with spread betting and the concept of fixed odds. In actuality, it serves as an easier trading style than many others, insofar as understanding the ins and outs of the system are concerned. While the individual markets for binary bets vary depending on the broker you chose, the basic underlying principles remain the same.
Binary bets are quoted similarly to spread betting, which defines both the buy price, the sell price and the commission component taken by the broker. The outcome is then settled as either a win or a loss – numerically, that’s 100 or 0 respectively. If you buy a position and the market moves up, you win, whereas if the market falls, you lose.
Note that binary betting is not concerned with the volumes of movement in a market – it’s simply a bet on whether the market will move up or down. This makes it (theoretically) easier for the trader to call the outcome, and in essence, you can only ever be right or wrong – there’s no margin for a small gain or a massive loss.
Another example using forex markets: (in this article we discussed how to take advantage of spread betting on forex markets, lets see how binaries compare) a broker quotes spreads for binary bets on oil prices at 63-68. This represents a reasonable likelihood that the market will rise over the period, because the broker has effectively shortened the odds offered. The trader can buy at 68, and if the market rises, his profit portion is stake x (100-68). If the market falls, his loss is stake x 68.
This means there is a cap on the potential profits and losses that can be taken from a transaction. Unlike other derivatives, where the extent of market swings represent greater returns (or losses), it is only the direction of movement that factors in to the equation when dealing in binary bets.
Regardless of the market the binary bets are offered on, the fundamental concept works the same – bets are settled at either 100 or 0, and are quoted on spreads that sit somewhere within that range, allowing the trader to capitalize on forecast market movements.
Binary betting can be a particularly effective strategy when implemented as part of a wider trading portfolio. The flexibility it provides allows traders to speculate on market movements, either as an addition to their other trading activities or as a hedge against wayward positions in other transactions. A cost effective, straightforward, tax-efficient trading style, binary betting can be an invaluable tool when implemented correctly.
One of the key ways in which binaries can be used to good effect as part of a trading portfolio is in hedging. Hedging is the process of taking two complimentary positions to offset losses in either, with the ideal outcome being to provide traders with a win in either direction or to mitigate losses if markets move against their positions. Because binaries can be processed to determine exactly the profit or loss that will arise, they are a great tool for hedging, and can factor in to the risk calculus to help minimize losses.
Suppose you are backing and want to spread bet on the FTSE 100 to move considerably up on the day, off the back of some strong results and a strong close in the US markets. Spread betting on the upward movement of the market could pave the way for significant gains, but if the market falters, you could end up losing an equally considerable amount.
The solution? To sell the FTSE in a binary. This could lead to a situation where a rising market will cancel out the losses on the binary position, whereas if the market unexpectedly fell, you would be able to offset much of those losses by the downside gain on the binary bet. Of course, it’s all dependent on the prices and the spreads offered, but opportunities like this are available to help minimize certain of the risks associated with trading.
It is also possible to use binary betting to capitalize on market movements over short periods of time, as a sort of ‘double up’ to other positions. If oil prices look set to rise on the day, a binary bet could be a good way to enhance profits over the short-term, even if you have larger positions outstanding in the market for a longer time-frame. Because binary betting only works on the direction of the market rather than the extent of any movement in your favour, this makes it the ideal tool for capitalize on forecast market directional movements over shorter time spans.
Binary betting can be used in a variety of ways to bolster a trading portfolio, and depending on your individual trading style you might be able to integrate binaries to a greater or lesser extent in your trading. Either way, it is important to be aware of binaries as a comparatively straightforward trading option, to help maximize gains on the upside offset losses from elsewhere.
One of the key advantages of binary betting as a trading style is the ability to calculate your potential earnings and losses from a given transaction. Unlike many forms of trading, where the extent of a win is significantly dependent on the degree to which you’ve made the right call, binary betting moves on either a win or a loss – with settlement at a guaranteed level of either 0 or 100, it becomes simple to put a figure on your total liability or potential upside gain.
Binary bets are quotes between 0 and 100. The closer these spreads are to 100, the more likely an event is to occur – for example, if the FTSE is quoted at 89-94, it is thought very likely that the market will rise that day, with a maximum upside of just 6 times your stake. However, odds of 15-21 make an event unlikely in the eyes of the broker quoting the spreads, leaving a large scope for earnings on the upside.
Calculating earnings and losses in binary betting is an easy process. Here’s an example to illustrate the necessary calculation.
Suppose you bet on oil prices to rise, at spreads of 63-68, therefore buying at 68 at £10 per point. If your position loses on the day, you’re down £680 (68 x £10) – no more, no less. If your position wins, either by a 1 point market movement or a 10,000 point movement, your bet is settled at 100 – thus, 100-68 = 32, 32×10 = £320 profit. Note that the broker’s commission is already factored in, as the width between the 63 and 68, so £320 is your take home profit from the transaction.
Thus, the formula for calculating earnings with binary bets can be broken down as follows:
Winnings = (100 – buy rate) x stake
Likewise, for calculating losses, the formula can be express as:
Losses = Buy rate x stake
Of course, these formulae are reversed for short positions, i.e. if you ‘sell’ the market rather than ‘buy’. Nonetheless, the calculus of profit and loss with binary betting is arguably one of the most straightforward in investing, thanks to its fixed odds nature.
Advantages of Binary Betting
The advantages of binary betting are often misunderstood by experienced traders, who tend to write off binary betting immediately as an ‘incognito’ fixed-odds bet. While essentially it is true that binary betting presents a fixed odds investment opportunity, there are significant tangible advantages for the trader with an open mind.
One of the main advantages of binary betting that traders often overlook is the tax efficiency point. Like spread betting, binary bets are free of both Capital Gains Tax and Stamp Duty liability, which can deliver a saving in excess of 20% as compared to trading shares. Particularly with a tightening tax avoidance climate in the UK and the likelihood of ongoing increases in CGT rates, this can be a very significant benefit, with a real impact on your bottom line.
Another advantage afforded by binary betting is the inbuilt leverage presented by the transaction. While the leverage isn’t as wild or as straightforward as that afforded by spread betting leverage, for example, it is nevertheless still present.
For example, a fractional one-point movement can realistically generate around a fifty-fold return on your initial stake. At £10 per point or more, this can start to mean serious money.
At the same time, the leveraged component on the downside isn’t as severe as un-tempered leverage products, and is limited to the multiple of your stake and the difference between the price point you either bought or sold and the 100/0 settlement point, depending on the direction of movement and whether you’ve gone long or short on the position.
Similarly, binary betting also allows for easier short-term speculation, at a lower price point that investing directly. Because the commission component is contained within the width of the spread and there are no further commissions or interest charges (because leverage is inherent in the composition of binary bets), it’s a more straightforward calculation for the trader.
The advantages of binary betting make it an option well worth considering for traders of all levels. Whether you’re just starting to trade for the first time, or you’re an experienced investor managing a large portfolio, the benefits of binary betting are manifold.
Disadvantages Of Binary Betting
For all the advantages of binary betting, there are also several correlative limitations that traders are advised to take into consideration. As with all things, there are pros and cons involved in binary betting, so it’s just a case of weighing up both sides of the equation as a balancing act to determine when and how best to utilize binary betting.
One of the main disadvantages of binary betting is their comparatively wide spreads in comparison to other instruments and trading styles. Because binary bets take no consideration of the extent of market movements in either direction, and in comparison to other forms of trading the volumes of binary bets placed are much lower, binary betting brokers need some way to enhance their profit portion to ensure binary bets are worthwhile, and this often results in wider spreads than with other investment opportunities.
Inherent in the makeup of binary betting as a trading style is the capping of both profits and loss, limited to the difference between the buy/sell price and the 100 or 0 settlement price. This is an advantage on the losing side, but also a limitation on the plus side.
For example, if you buy the FTSE 100 at a spread of 47-51, the maximum earnings you will receive from the market moving positively are equivalent, whether or not the market moves by 1 or 100 points. In contrast, a spread betting position could capitalize on a strong rise in the market multiple times over, thus for a ‘sure-fire’ position showing signs of a heavy positive movement, it may be more viable to opt for spread betting or some other trading style.
Likewise, there is no margin for stop losses (or limits) built into the binary betting transaction. This essentially means that there’s little scope for automatically cutting out of a losing position – by nature, the bet is binary, so losses are taken at 0 on a ‘buy’ trade. Of course, this does have the advantage of bringing certainty to the equation, in the sense that traders are aware of their potential losses before entering the position, but these may be higher than those that would arise otherwise in transactions where stops can be more readily placed.
Binary betting does have its fair share of drawbacks, but as with any method of trading, these tend to be outweighed by the positives, and in particular the flexibility binary betting brings to the trader’s arsenal.
Binary Bets: Final Thoughts
The trajectory of binary betting has largely paired that of spread betting, with the two closely aligned as services offered by spread betting brokers. As a degree of flexibility, binary betting can add significant value to the trader’s portfolio. But aside from flexibility, there are a number of other reasons why binary betting is proving a popular investment method.
One of the key strengths as far as binary betting is concerned is the fact that no matter the degree of market movements, the trader will always profit a fixed amount from an upward rise. This, of course, caps profits at a ceiling, but it allows the trader to capitalize on market direction as a binary, straightforward proposition – i.e. the trader either wins big, or loses in equal measure.
This allows traders to focus solely on the factors that contribute to market or index movement, rather than requiring an analysis of pricing, which can be a particularly tricky, mathematic-intensive and deeply involved process. Simply judge whether a market or commodity will do well or not over the period, and take a corresponding position.
Another handy feature of binary betting is the capped losses it provides. Unlike many other leveraged trading products, binary betting will only ever cost you the multiple of the buy point and your stake. This allows traders to guarantee, with absolutely certainty, their exposure to loss (and indeed the profits available to them) from a given transaction.
These features combine to make binary betting a particularly useful addition to the trading line-up. Many more experienced traders still consider binary betting to be something of a consumer investment product rather than a serious investment opportunity, but this often comes from a place of market snobbery. In actual fact, binary betting provides an extremely useful trading basis for both novices and the more experienced trader, with all the advantages of spread betting, less the volatility in returns.