Dec 222013
 

Learn how binary options trading works with our free binary options simulator.

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Exchange Traded Binary Options / Is Binary Options Trading Legal In The US?

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60 Second Binary Options / Binary Option Trading Signals 

Binary Options Scams and Fraud / 60 second binary profit system

Dec 112013
 

The History of Binary Options. This article was published on MAY 15, 2008

A New Financial Instrument – Binary Options

This week I was doing some more traveling and was preparing to write an article on expiration day trading since tomorrow is expiration day for the May options.

However, last week the American Stock Exchange (that’s where I was a Market Maker for 8 years) started trading a new product: binary options. Since I want our Online Trading Academy students to be some of the first public traders to know about this new product, I’ll do the expiration day article at a later date and discuss this exciting new financial instrument today.

As I used to explain to students in the options course, there are only 2 types of options, Puts and Calls. (Failure is not an option.) Well, now there are 3! On May 1st the AMEX announced that beginning May 8th, last Thursday, it would start trading a new type of option called Fixed Return Options or FROs for short. This is just a fancy name for binary options. Binary usually refers to something that can exist in 1 of 2 states, in this case, the 2 states are “worth $100” or worthless. I have also heard FROs referred to as “cash or nothing” options.

binary options 2008

There are 2 types of FROs; High Finish and Low Finish. They are somewhat analogous to Calls and Puts, respectively. I’ll give a quick explanation, and then I’ll flesh out the details in the rest of the article. If a High Finish option or a Low Finish option is in-the-money (ITM) at expiration, then it’s worth $100. Otherwise, it’s worth nothing. So if we buy 1 XYZ High Finish July 25 FRO for $45, it will be worth $100 if XYZ is over $25 at July expiration and therefore make a profit of $55. However, if XYZ is $25 or lower, the FRO will expire worthless and we will lose the entire $45. It’s actually a pretty simple concept, although some of the details are a little bit tricky.

Last week 20 FROs started trading and it is anticipated that many more will be introduced in the future. For now the list is composed of 12 stocks and 8 ETFs as follows:

S Y M B O L
STOCK STOCK FRO
Apple, Inc AAPL AXO
Cisco Systems CSCO CMQ
Citigroup C EFH
General Electric GE DOC
Goldman Sachs GS TLG
Google GOOG TBA
Home Depot HD HEM
IBM IBM TSB
Intel INTC IDP
JP Morgan Chase JPM LIV
Microsoft MSFT RIS
Wachovia WB BWK

 

S Y M B O L
ETF STOCK FRO
DIAMONDS DIA DCQ
MSCI Emerging Markets EEM PTT
Russell 2000 Index Fund IWM DNZ
Oil Service HOLDRS OIH HKT
PowerShares QQQ QQQQ NKN
SPDR S&P 500 SPY SQY
SPDR Energy XLE LPA
SPDR Financial XLF RZP

The FROs will trade with the same strike prices and expiration dates as the underlying stock or ETF. The exception being that LEAPS FROs will not be traded, at least for now. A complete FRO symbol will add the standard month and strike price code to the FRO symbol shown in the table above. For example, the Intel July 25 High Finish and Low Finish symbols are IDPGE and IDPSE, respectively.

Just like regular Put and Call options, you can open a position by either buying or shorting a FRO. The position can be held to expiration, or can be closed prior to expiration. These FROs are all European style exercise, meaning that they can only be exercised at expiration and the exercise will happen automatically, you don’t have to call your broker. If they’re ITM they get exercised and if you’re short, you will be assigned. Notice that they settle in cash. In other words, no stock changes hands, only cash. Also, you don’t have the issue of unlimited potential losses when you are short a FRO as you do with Put and Calls. On the other hand, you don’t have the possibility of unlimited gains either.

Suppose it’s expiration Friday and a large investor has a large position of XYZ High Finish FROs and the stock is trading right around $25, let’s say $24.98 bid offered at $25.01. That investor might be tempted to pay up to push the price of XYZ over $25 if he is long, so that his FROs are ITM, and now worth $100. If he is short, then he may try to sell XYZ to keep the price under $25. To prevent that sort of manipulation, the AMEX came up with the idea of using an “FRO Settlement Index” instead of the closing price on expiration Friday to determine if the FRO is ITM or OTM. This Index is the Volume Weighted Average Price or “VWAP” of all the stock traded that day.

For example, if the following shares of XYZ traded on expiration Friday,

Shares

Price

Value

3,500

24.93

$87,255

12,000

24.96

$299,520

900

25.01

$22,509

2,700

25.03

$67,581

6,200

25.04

$155,248

25,300

$632,113

Then the VWAP would be equal to $632,113/25,300 = $24.98 and that amount would be used as the FRO Settlement Index to determine if the FRO is ITM or OTM.

Since this product is so new, there hasn’t been much time to evaluate how the pricing will work. If you want to become comfortable with these FROs, I think it would be worthwhile to try to determine how each of the variables that are used to calculate the old fashioned Calls and Puts (stock price, time to expiration, volatility, risk-free interest rate, and dividends) impact the FROs. Next you can think about the Greeks, and how they differ from the Greeks on Puts and Calls.

I am sure that many professional traders are spending lots of time analyzing these FROs to determine if and how they can be used for arbitrage trading, speculating, hedging, etc. It is expected that this new instrument will become a huge product as time goes by and they become better understood. Learning about them at this early stage in their development can only lead to more opportunities in the future. I’ll keep you posted of any new developments.

Stan Freifeld

Republished with permission from tradingacademy.com

Back to the present / 2013:

It would probably be smart to ad a disclaimer or warning here because of the present “situation” regarding Binary Options .

Press release from June 12, 2013:

The Commodity Futures Trading Commission’s (CFTC) Office of Consumer Outreach and the Securities & Exchange Commission’s Office of Investor Education and Advocacy are issuing this Investor Alert to warn about fraudulent schemes involving binary options and their trading platforms. These schemes allegedly include refusing to credit customer accounts, denying fund reimbursement, identity theft, and manipulation of software to generate losing trades.

Please visit the CFTC to read the entire press release: http://www.cftc.gov/PressRoom/PressReleases/fraudadv_binaryoptions