The most important attribute of binary options is that your maximum risk and potential profit are clearly defined, no guess work is required. Take last October’s sell-off, that at the time appeared like it could be the big one.
In the October sell-off many traders believed their downside was protected only to see stop levels blown away and volatility models turned upside down. This is what happens in major corrections and bear moves. Sometimes, relatively often, the rebounds from these moves are more violent than the sell-off making timing entries more critical than ever. But an interesting thing happened in October. The S&P 500 followed a relatively predictable technical model. The Nadex US 500— binary options contract based on the CME E-mini S&P 500 Index Futures — would have allowed you to place potentially high reward low risk trades based on the market respecting certain long-term technical benchmarks.
Most importantly, you could have been involved in the market, either long or short as there were opportunities on both sides, and still sleep at night as your risk would be fixed.
Let’s take a look at a few potential trades. Friday Oct. 10 the technically important 200-day moving average was taken out. Monday Oct. 13 the market rallied back above it by midday before obliterating it. A trader could have taken an intraday long position on a retest of this level. While a long position in the E-mini S&P 500 would have eventually been a loser, a smart trader could have taken profit. While this may seem like hindsight, it is important to keep two things in mind: Importantly technical levels are usually retested and the overall tone was negative.
More importantly the way the 200-day moving average was taken out showed extreme weakness and the next level was the 50-week MA around 1882. This level held since the correction in the second half of 2011. In 2012 it was breached twice midweek only to settle at or above it. So the level was important and was taken out on Oct. 13 as was the August low, breaking a series of higher highs and higher lows. At this point it was clear that the correction was more significant than any other in 2014. One could speculate that there was a strong chance it would reach a 10% drawdown from the Sept. 19 high. That level was approximately 1820, still 45 points below the Oct. 13 low. Taking a position on a short-term US 500 binary option at or below this level would have been relatively inexpensive, especially after the market rebounded on the following day. If you are looking for a big move than you should be focusing on OTM binaries… where your potential ROI will be much higher than the ATM or ITM. Your payout is fixed so this is the best thing you can do with volume.
The best opportunity would have been purchasing a weekly binary sometime during massive sell-off on Wednesday Oct. 15 (or the next day’s retest of lows) on a close at or above the 50-week simple moving average, 1880. History indicated that the market would try to get back to that level, even though the E-mini S&P 500 dropped nearly 70 points below this level. By Friday afternoon the market had rallied above the level. At this point the trade would have been profitable. The trader could have taken a profit and not sweat out the nerve racking final hour where it straddled the important technical level before eventually settling at 1881.
The important thing to note is that there were significant technical levels the market needed to test in the battle between bears and bulls and savvy traders could have used this knowledge to make profitable trades using binary options.
Futures, options, and swaps trading involve risk and may not be appropriate for all investors. Past performance is not necessarily indicative of future results.