Binary Put Option Explained

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What are binary options

Binary options are a great financial instrument and are a great way how to make money on the Internet. It is easy to understand, comprehend and trade.

Binary options are just one of many option types. They are characterized by their simplicity as the value of maximum profit or loss is known to both buyer and seller beforehand. Word „binary“ means that on expiration date buyer gets either predefined profit or nothing at all.

Binary options can be traded on regulated markets but are usually unregulated, traded on Internet and prone to fraud. For example, American Trade Commission issued warning to investors regarding binary options.

Binary option types

The most important factors for every binary option trade type are strike price and time for which the option is considered valid – called expiration time. Investor therefore speculates whether the price of an underlying asset (gold, silver or company stock) at the end of the expiration time (i.e. in 5 minutes or 2 hours) will be higher or lower than at the beginning of the trade.

Almost always this involves call and put binary options.

CALL Binary Option

In this case the trader speculates and hopes the price will rise.

Trader makes a call trade at 12:00 for 1 hour (with 60 minute expiration time at 13:00) with price $1.2 per stock. The trade amount is $100.

Only two possible outcomes:

  • At 13:00 the price is higher than $1.2 (i.e. $1.21 or $1.5) and the option expires IN THE MONEY. Thus the trader makes money. With returns of around 85 % trader could make $185 out of which $100 is the returned amount invested and $85 is pure profit.
    The price is lower than $1.2 (i.e. $1.19 or $0.9) and the trader loses money. The amount invested ($100) is therefore not returned.

PUT Binary Options

In this case the trader speculates on the oposite. That the asset‘s price will drop.

Example:
Trader makes put trade at 15:00 for 1 hour (option with 60 minute expiration time at 16:00) with price $1.2 per stock. The trade amount is $100.

The Call/Put, Up/Down or High/Low Option Explained

The following lesson introduces the call/put or high/low option in binary options.

Introducing the Call/Put Option

The peculiarity of the binary options market is the ability to trade an asset in different ways. This is quite different from other markets where profit or loss is defined in terms of an asset’s up or down movement.

Another peculiarity is that all binary options trades have a time limit. The trader must set an expiry for a trade. In the first part of this series on binary options trade types, we will examine the trade type that closely resembles the kind of trades that traders are used to, and this is the classical Call/Put trade contract.

The Call/Put goes by several names, depending on the platform the trader is using. Some of these names are Up/Down, Rise/Fall, Above/Below or High/Low. Whatever the nomenclature, the trade is the same: the trade outcome depends on the asset ending the trade at a price that is higher or lower than the market price at which the trade was entered.

How Does the Call/Put Option Work?

The trader selects an asset and does his trade analysis, then chooses the amount he wants to invest in the trade. He then selects either “CALL” or “PUT”, chooses an expiry and submits the trade for execution.

The expiry is just as important as the trade direction. It will not serve the trader any purpose to get the trade direction correct if the objective cannot be achieved within the set time limit. With the Call/Put trade, a late performance is a losing performance. The asset has to move in the chosen direction and do so within the time allotted to the trade.

Call/Put Trade Example

Let us take the example of a trader named Juande, who has a bullish bias on crude oil and decides to buy a CALL binary option at 78.35, with a 1 hour expiry. For this trade to be a winner, the price of crude oil must be at least 78.36 or higher by the time the trade ends in an hour.

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If the price of the asset is at 78.35 by the time the trade ends in an hour, the trade will end at breakeven and the trader’s investment amount is returned to his account.

If the price of the asset is below 78.35 in an hour’s time, the trade will end as a loss and Juande will lose his trade investment.

There is a modification of the Call/Put trade which is the 60 second trade. The 60 second trade is basically a highly speculative Call/Put trade type that has a compulsory expiry of 60 seconds.

How to Trade the Call/Put Option

The Call/Put option is purely based on the asset going up or down in price. This makes it amenable to being traded using indicators and expert advisors. It is possible to download a demo trading forex platform such as the MT4, create an indicator that works on such a platform to derive trading signals which can then be adapted to the binary options platform. Alternatively, a trader can purchase an existing indicator and adapt it to trade the Call/Put binary options contract.

When does it make sense to trade the CALL trade?

a) The decision can be made by technical analysis, and if the indicators all point towards a bullish outcome within the estimated time frame, then it would make sense to trade the CALL trade. Technical analysis can be made from indicators and from the charts (chart patterns and candlestick patterns).

b) If there is a news release for an asset that has a bullish outcome, then this can be used to trade the CALL option.

Conversely, it makes sense to trade the PUT option when:

a) There is a fundamental news release that has a bearish outcome for the asset.

b) A technical decision using technical indicators, bearish chart patterns or bearish reversal candlestick patterns is made from the chart information on the asset.

More About Adam

Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

Short Put Overview

Kevin Ott

The short put option strategy is a bullish, neutral, and minimally bearish option trading strategy that has two forms: cash secured and naked.

Selling cash secured puts means that a trader holds enough cash to have the underlying asset “put” to them. Selling naked puts involves trading on margin where the trader doesn’t have available funds to secure the short puts. Therefore, naked (or uncovered) short puts have an inherently high amount of leverage.

The short put option strategy is popular due to the inherent probabilities of options. Options that are far-out-of-the-money have a higher probability of expiring worthless. Many professional investors like Warren Buffett and *unfortunately* Victor Niederhoffer have been big proponents of the short put option strategy. If managed properly, short puts can be a very useful options trading strategy to generate income from theta decay and possibly acquire the underlying asset at lower prices.

Key Points

  • Although the risk is not unlimited, selling puts is highly risky
  • In exchange for the large amount or risk, there is a high probability of profit
  • Most puts expire worthless, so selling expensive puts to fearful investors has yielded consistent profits for many

Tastyworks is one of the most popular online brokerages to trade short puts because of $0.00 commissions and free professional options trading platforms.

Short Put Option Strategy Definition

-Sell (short) 1 put

Note: like most options strategies, you can sell puts in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM).

Short Put Example

Stock XYZ is trading at $50 a share.

Sell 48 put for $0.30

Maximum Profit and Loss for the Short Put Option Strategy

Maximum profit for a short put = PREMIUM RECEIVED

Maximum loss for a short put = UNDERLYING ASSET GOES TO ZERO

Although the max loss is indeed limited, losses with short puts can mount rapidly due to expansions in volatility and sell-offs in the underlying.

In the example above, the max profit is $30 ($0.30 per contract). In this example, the max loss is $4,770.00. This would be the absolute worst-case scenario. Although it’s very rare, stocks occasionally do go to zero.

This is a pretty unfavorable profit-loss ratio. So what’s the catch? Well, in exchange for this high potential loss, short puts have an inherently high probability of deprecating and ultimately expiring out-of-the-money and ending up worthless.

Short Put Summary

Maximum Profit Defined
Maximum Loss Defined but severe
Risk Level High
Best For Creating a long position in a stock and collecting premium
When to Trade When you are bullish or neutral on a stock
Legs 1 leg
Construction sell put option
Opposite Position Long put

The breakeven point for a short put = premium received subtracted from the put option strike price.

In the example at the top of this page, the breakeven point for stock XYZ would be $47.70. In other words, since XYZ is trading at $50, it has to decline $2.30 before the trade becomes unprofitable. It is important to note that this is the break-even point at expiration. Stock XYZ can decline $2.30 at anytime before expiration and the short put will not necessarily break even.

Why Trade Short Puts?

The short put option strategy is a fascinating options trading strategy that is particularly popular among professional investors. Why? Primarily because of the probabilities of options.

Puts that are very far out-of-the-money have a low delta. Therefore, far OTM puts don’t dramatically change in price without dramatic downward moves in the underlying asset. Furthermore, far OTM puts only pay the buyer if the underlying asset declines dramatically prior to expiration. Many investors want (and sometimes need) to have protection against dramatic declines in a particular instrument. Other traders are willing to take this bet and sell these puts.

If the underlying asset doesn’t decline, and/or if volatility contracts, it’s fairly easy to make money selling overpriced puts. Plus, the short put option strategy makes money if the underlying asset stays the same, increases, or minimally decreases. Other traders sell put options not only to collect the premium, but to also potentially acquire the underlying asset at a lower price. This strategy of going long is only possible with cash-secured short puts, not naked.

In the example above, if you wanted to by XYZ stock at $48, even though it is currently trading at $50, we could sell a $48 put for $0.30. If the stock isn’t below $48 at expiration, you keep the $30 in premium. If it is at or below $48 at expiration, you will be put 100 shares of XYZ at $48 and still keep the premium.

Our breakeven for this short put trade is $47.70 because this is the strike price of the short put minus the credit received. This is a common approach among institutions looking to accumulate stock.

Margin Requirements for Selling Puts

Because short puts can be sold both naked and covered, margin requirements for placing the trade will vary. In the example above, to sell 1 covered $48 put of XYZ stock, you would need roughly $4,770 in buying power; this is the max loss for the trade.

For naked short puts, the margin requirement is typically 20% of the price of the underlying asset.

If you want to sell puts naked (i.e. uncovered options), then you would be using additional leverage. This is where some traders (like Victor Niederhoffer) run into trouble. With that same $4,800 in buying power, with a naked options position, you could sell typically sell 5 puts. The margin requirements for short puts depend on your options broker as well as the underlying asset. Futures options in the US work under SPAN margin, so requirements to write options are typically less than they are for equities.

If you have a portfolio margin account, the requirements for uncovered equity options and futures options will more or less be the same.

What about Theta (Time) Decay?

Theta decay for a short puts is extremely favorable. Because puts tend to trade richer than calls due to the possibility of a “crash,” puts are often quite expensive. And because puts are expensive, option sellers take advantage of the high level of theta decay.

Everyday, premium will be systematically priced out of the puts, and the seller of a put option will collect this premium. It’s worth noting, however, that the algorithms that price and trade options are fully aware of an option’s premium decay. Suffice it to say that theta decay is not necessarily an “edge” in trading.

Nevertheless, entire hedge funds and individual traders have built their trading careers around selling naked puts and managing to dodge volatility explosions and market crashes. Basically, traders like selling puts because it works a lot of the time. It’s just that on the rare occasion when it doesn’t work, it can go VERY bad VERY quick.

When Should I close out a Short Put?

Since the short put option strategy has a limited profit, short puts should always be closed out when the premium is near zero or less than $0.05

This is because the last 5 cents of a put, even if it’s far OTM, can stay bid almost up until expiration. At a certain point, the risk/reward of holding a short put simply becomes unfavorable when there is no premium left to decay. This holds true even for short puts that are worth less than $0.15

If a short put has reached its max profit, it is always wise to close it out. The only exception would be a short put that is significantly OTM with a brief amount of time until expiration. By leaving the short put on, you could potentially save on commissions.

For short puts that are unprofitable, it is possible to continue to roll the position until volatility contracts or the price of the underlying asset goes up.

Anything I Should Know about Expiration?

Yes. If short puts expire OTM, there is nothing that needs to be done. Often times traders do not want to take unnecessary expiration risk, so they close out worthless short puts prior to expiration. This is the case for options that settle after they expire, like some series of SPX options.

If a short put is in the money at expiration, and past the break-even point, it will be a losing trade. If this happens, an assignment risk exists.

An assignment risk technically exists any time a short put is in-the-money on a US stock, although it’s very uncommon for short puts to be assigned prior to expiration unless they are deep ITM.

If a trader does not have enough money to acquire the underlying asset at the strike price of the short put, i.e. an uncovered put option position, a margin call will be issued after expiration. Typically options brokers notify their clients if a short options position is going to have a negative margin impact.

If the trader has enough money to acquire the underlying at the short put strike price, the appropriate number of shares or futures contracts will be assigned to the account.

Important Put Selling Tips

To the surprise of many, short puts (whether naked or covered) resemble a significant portion of professional trader’s portfolios. This is primarily because selling puts is a fantastic way to collect option premium and possibly accumulate more of an underlying asset at lower a lower price.

Additionally, short puts are also a popular way to express a bearish outlook on volatility itself. When volatility decreases, the value of puts decrease as well.

However, the flipside to that coin is that short puts are sensitive to volatility increases. This is because volatility (as discussed in the beginner’s guide to options) is a major component in an option’s price. If volatility dramatically increases, a short put position will exponentially increase in value leaving the put writer holding the bag.
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End of the Day – Binary Options Strategy

Most investors who first time come into contact with Forex market or binary options (BO) tend to choose the lowest possible intervals, counting on quick profits. In the article below we would like to present another – definitely safer approach to the BO – based on the end of the day strategy. Its main purpose is to play options expiring at the end of trading day.

Low intervals = high risk

Brokers of binary options now offer options for the most popular currency pairs, commodities and indexes expiring within 60 or even 30 seconds. While this can be an interesting way to invest and secure positions for experienced investors, for a newbie trader this can be to dynamic environment leading to a quick account wiping.

To get familiar with the market environment and how it works, it is definitely better to focus on options with longer expiry time. Great examples are intraday options that expire at the end of the day (usually between 21 and 24 depending on the session and the selected item).

What are the biggest advantages of this solution?

  • Investor makes decisions based on H1 chart or higher – the technical situation is not so volatile and we have more time to make a decision.
  • A clearer trend is drawn during the entire session or earlier – thus avoiding the risk of unnatural behavior during volatility due to macroeconomic data and underlying events.
  • You can identify a longer market trend, which reduces the risk by giving you a greater advantage and a chance of effective closing options
  • Overtrading protection – By investing in end of the day options, the investor is not in a position to over-trade as would be the case for short-term options (for example, a dozen transactions at the same price within a single session)
  • Favorable return levels for options expiring at the end of the day – on average 80%.

Every day in the morning on Comparic.com we present two analyses for options expiring at the end of the day. The technical image is based on Price Action combined with S/R lines and trendlines. In the following strategy we would like to present a slightly different approach, using more technical analysis tools.

Basic assumptions of the end of the day strategy

The approach proposed in this article is based on several basic assumptions:

  • Investing based on Price Action and its elemental formations
  • Using H1 (hourly) charts – regardless of the MT4 platform provider, hourly candles always look the same (H4 graphs may differ significantly from each other due to the different server times). More sophisticated traders can also use the M5 interval to make a more precise entry into the transaction
  • Use of pivot point (PP) and Fibonacci retracement in intraday analysis
  • Investing in the most popular assets – the main currency pairs are characterized by the highest liquidity, the smallest amount of incorrect quotes, and the most favorable returns
  • Limited exposure to a particular currency to reduce risk – Avoid placing multiple positions, for example Pound (PUT GBP/USD, PUT GBP/JPY and CALL EUR/GBP). In this case, when the market moves “wrong” direction than expected, all positions will be a loss. Therefore, it is important to choose different currency pairs
  • Analyses are made in the morning – preferably before 12:00. Alternatively, they can also be done in the afternoon, but not later than 3 hours before the option expires.

Preparing the chart

At the very beginning, we need a Pivot Point (PP) indicator. It is not available by default on most MetaTrader platforms, but there are plenty of free and nice looking versions on the net. The indicator used in this article can be downloaded from here (link). Indicator shows main pivot point, three support and resistance pivots (S1-S3, R1-R3, and so-called mid-pivots).

In addition to the PP itself, the graph is also supplemented by SMA (simple moving average) with interval 33 and shift 0. As a result, the graph should now look like this:

NZD/USD H1 graph with pivot indicator and 33 SMA average (vertical lines are interval separators – individual sessions – which can be set in graph properties)

Once the graph is ready, you can focus on its proper analysis. Below you will find the rules for PUT and CALL options

The conditions necessary to open the PUT option – expecting declines

The end of the day strategy for the PUT option assumes the following assumptions:

  • Extension of the Fibonacci corrections on the price of the previous day session. If the session is bearish, the indicator is stretched from maximum to minimum, if it was bullish we do it opposite way. Fibonacci in this case is an additional confirmation of relevant technical levels that can trigger a reflection of the price.
  • The session should start under daily PP and 33SMA (pink dashed line called Pivot and dynamic moving average). When the Pivot line overlaps with the support/resistance of previous sessions, investor receives an additional confirmation of the significance of the level
  • At the moment of testing the daily PP level from below, the PUT option is considered. When the zone coincides with 33SMA and Fibonacci abolition, the signal is stronger
  • It is important that a signal from Price Action (for example pin bar) appears on the resistance zone, which is an additional confirmation of the position.

NZDUSD – option PUT

The above example shows PUT option explained step by step:

  • The previous session was bearish – Fibonacci stretched from top to bottom
  • Another session began under Pivot and 33SMA levels, so we are expecting declines (PP additionally coincided with a 38.2% abolishment of the previous day’s declines).
  • Due to the fact that price was far from the set resistance levels, in the morning it was impossible to make a trading decision.
  • Such an opportunity appeared only in the afternoon when price falsely tested the confluence of resistance in the form of 33SMA, PP and Fibo 38.2%. In addition, at that level a pin bar candle was created.
  • Once it was closed, you could open the PUT option
  • The price until the expiration of the option (21:00) dropped 30 pips, the position was booked as profitable

Conditions required to open the CALL option – on growth

The end of the day strategy for the CALL option assumes the following assumptions:

  • Fibonacci stretched the same way as in the PUT option
  • The session should begin over a daily PP level and 33SMA (pink dashed line called Pivot and dynamic moving average). When the Pivot line overlaps with the support/resistance of previous sessions, the investor receives an additional confirmation of the significance of the level
  • At the moment of testing of the daily PP level, the opening of the CALL option is considered. When the zone coincides with 33SMA and Fibonacci cancellation, the signal is stronger
  • It is important that a signal from the Price Action (for example, the pin bar) appears on the support zone, which is an additional confirmation of the bullish attitude.

EURJPY – option CALL

The above example of playing the CALL option is explained step by step:

  • The earlier session was bullish – Fibonacci stretching from minimum to maximum of the day
  • The first opportunity to open the CALL option came in at night when we had the first PP test and 38.2% of the Fibo correction – at this time usually no one trades
  • The real commercial opportunity appeared in the afternoon (second candle marked in red)
    Very long bottom wick falsely broke 33SMA, PP and 38.2% of Fibonacci
  • Once the H1 candle was closed, it gave a signal to open option CALL. The price until closing time increased 30 pips, so the option was profitable.

The above examples show the exact rules for playing the OB based on the end of the day strategy. Here are some additional examples based on the strategy described, including the moments when this option should not be opened.

Examples of setups based on the end of the day system

In the above we could see two book examples of CALL and PUT options based on the end of the day strategy. However, it should be mentioned that such situations will not happen every day – much more often the market will show signals of lesser strength, but still having high profit potential. Few examples of such systems are presented on charts below.

Option CALL for USD/JPY

Session earlier was bullish so Fibonacci stretched up. The quotes are open over 33SMA and PP so the investor is betting on growth. However, during the day test of the daily Pivot doesn’t occur – does it completely excludes trade? Not necessarily. This is why additional Pivot levels (standard deviations of the main pivot) are also used, which are denoted S1-S3 and M0-M5. In this case Price Action formation (pin bar + inside bar) tested 23.6% of Fibonacci, 33SMA and mid pivot M3. After finishing the formation, trader was given the signal to open CALL option – which would close at the end of the day with a profit.

No option on EUR/USD

On H1 chart of EUR/USD Fibo, Pivot and 33 SMA suggested declines. However the candle signal on was not fulfilled on confluence of resistance and additionally Pivot S1 did not allow the price to drop bellow to the end of the session. There was no signal and no opened option.

Option PUT on GBP/USD

Example of far from the ideal signal – although the marked red candle tested 33SMA and Fibonacci resistance, it did not touch the Pivot level while staying over the pivot M2. Investor could, however, consciously assume a higher risk and open PUT position based solely on these signals. On the chart above, this would be the right solution, because the price at the end of the day actually closed lower, guaranteeing profit from the option.

CALL option on AUD/JPY – Failed

An example of a failed option – although the pin bar tested from the top PP and 50% of the Fibo correction, it was below 33SMA. Initially, the price moved up, but during the European morning it stopped at the first pivot resistance (R1), which caused the declines to the end of the day – resulting in CALL option closed with loss.

CALL option on CAD/JPY

Another textbook example of the CALL option. All assumptions fulfilled (Fibo, PP and 33SMA test), additionally pin bar signal – option closed with profit.

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