Binary Options - Market Analysis for Feb 13th, 2017

This is a post about Nadex which is a US Exchange that deals in Binary Options, Spreads and other exotic derivatives for a lot of instruments out there. I don’t have any affiliation with Nadex, I’m just one user of the products.

Binary options have been in the mainstream periodically, it seems that there are bubbles of popularity and then they deflate. That is not helped by the fact that in the US there was no easy way of trading them for retail traders so a whole offshore market for trading binary options appeared. Of course most of that offshore “market” was just a bunch of crooks that pretty much stole everyone’s money one way or another (most of those shops were ran out of Cyprus, that tells you a lot).

The fact of the matter is that the SEC and everyone else came down hard on binary options and US residents are in fact forbidden to trade them at all with a few exceptions. The exceptions include binary options for VIX that CBOE offers, all of the binary options that Nadex offers, and a new set of binary options from NYSE that were introduced last year but that no one seems to trade (they are called ByRD’s) there is one more exchange for some exotic FOREX options but I can’t never remember the name (you can tell I don’t trade FOREX at all).

So there you have it, there are ways to trade legit binary options (regulated, transparent and centrally cleared markets) however there is the trick of actually making money with them :)

Binary options are not harder or easier to trade than plain vanilla options, in fact if you have been a G.O subscriber for a while now, you must have notice that the bulk of the lotto trades we do here are basically SPX binary options (done as vertical spreads). And as you can see we have been pretty successful with  those. 

The most important thing when trading any product is to have an edge, and clearly when implied volatility is so low we can buy incredible cheap gamma (especially for call options) that produce tremendous results. Cheap gamma gets translated very well into binary options as they are in fact the purest expression of gamma (our vertical call spreads are just rough imitations). So for our plays the main reason I use vertical spreads (and in fact very tight vertical spreads) is that I want to replicate binary options.

You can think about a binary option as a vertical spread where the distance between strikes is very small (in fact it is almost zero). Think about them as vertical spreads where the limit of the difference between strikes approaches zero.  Because of that, binary options represent gamma in a perfect way, the reason is that the gamma of a vanilla option is basically the delta of a binary option. So when the price of a binary option moves, you are actually seeing gamma in action right there, unfiltered.

If you folks like the idea I can get deeper into binary options theory and some practical execution tips in Exchanges like Nadex. The main advantage right now over our vertical spreads is that Nadex offer very flexible expirations (minutes, hours, end of day and end of week). The main disadvantage is that some option lines in Nadex have very wide bid/ask spreads and it is almost impossible to provide liquidity there (so we need to take liquidity to execute the trade). But even with that, in days like today was very simple to extract edge from the end of day ES binaries as pretty much *all* of the binary calls were massively mispriced.

So let me know and I’ll post a series of articles about that.