Binaries: ‘To be or not to be.’

View from the dealing floor. Franz Khanna works on IG’s dealing floor in London. To learn about CFD trading visit: www.ig.com/uk/trading-cfds

When Shakespeare penned those immortal words he would not have had in mind the short-term gain (and sometimes pain) enjoyed by those who choose to trade financial markets through the medium of binary spread betting. Such a product involves speculating on whether a stated outcome in a particular financial market will or will not occur. Typically short-term in their duration, ‘binaries’ offer savvy speculators the opportunity to make (or lose) significant amounts of money from minute moves in an underlying asset.

The price of any binary bet will vary between 0 (where the bet will ultimately settle if the stated event does not occur) and 100 (the settlement–if the event does ultimately happen). This price can be seen to be the percentage chance of the event finally happening.

By way of an example, consider a binary bet on “FTSE to finish up” for a given days trading. Assuming the FTSE to be down a handful of points with an hour or so of trading remaining the price of this “FTSE to finish up” binary may be, for example, 33/36. An investor with a bullish outlook may believe that the market is likely to rally and ultimately finish in positive territory. He/she would look to buy the binary at 36, to a given stake size, let us say £10 per point. If the investor is correct and the FTSE does indeed finish up on the day then this particular Binary market will settle at 100. The investor would be rewarded with a 64 point gain in £10 per point, and therefore a £640 profit. If they had been wrong and the FTSE had ultimately settled down on the day, the investor would squander the 36 points paid, amounting to a loss of £360. If the investor had instead taken the view that the FTSE would remain in the red he/she could have chosen to ‘sell’ the binary at 33, hoping to make £330 from the trade.

Note that the magnitude of the final net change in the FTSE does not affect profit or loss at expiry. Buying into the “FTSE to finish up” market means that an investor does not care whether the market ultimately settles up 1 point or 150 points; in both instances the statement (“FTSE to finish up”) has proved to be correct and so the binary market settles at 100. In this sense binary betting differs markedly from traditional investing, where typically traders are rewarded for how right their views are, with a relatively large move in the chosen direction resulting in a profit– or vice versa and a loss. This makes binaries appealing in times of low volatility, where underlying market moves may be slow and small in magnitude, making it harder for investors to garner much by way of profit within a small time frame.

In addition, since the investor is aware of their potential profits/losses from the outset – owing to the settlement boundaries of 0 and 100 – the product is relatively limited in risk in that they will know, up-front, what the exact risk and rewards will be for their trading decisions.

Binaries can relate to events in any number of underlying financial markets including the major indices, commodities and foreign exchange pairs traded globally. IG helped pioneer the product over a decade ago and now offers what is widely considered to be the broadest and most comprehensive range of binary markets available to retail investors with thousands of binary prices available online at any given time. Indeed, many can be traded day or night.

Spread bets and CFDs are leveraged products. Spread betting and CFD trading may not be suitable for everyone and can result in losses that exceed your initial deposit, so please ensure that you fully understand the risks involved.

This information has been prepared by IG, a trading name of IG Markets Limited. The material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.