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Boasting the potential benefits of a spread bet while limiting exposure, binaries provide an innovative way to take on the markets

by Nick Sudbury

Investors who buy shares or who spread bet on their prices need to be able to spot a reasonable size move in order to make a decent profit. Fixed odds bets are rather different as they are structured to either succeed and produce a preset level of winnings or fail and finish worthless. This means that they only need to be correct by one point to pay out a leveraged return and although the trader is risking his stake he knows his loss can never be any higher.

Fixed odds are a simple yet powerful concept that allows traders to make money by taking a view on a particular price movement. All the bets are valued using risk neutral probabilities, which means they factor in the same chance of the market going up as going down. The upshot is that those with a different viewpoint – perhaps as a result of spotting a strong trend – would see value in the trade and could look to exploit it.

Quick as a flash

Fixed odds services like BetOnMarkets.com and BetsForTraders.com allow people to define the exact bet that they want, with the trade running from the instant they execute their order. The simplest type of position is a binary on a market to rise or fall over a certain period, an example being the FTSE to be higher in three hours time.

Binaries are typically available over periods of anything from an hour upwards, but for those interested in shorter term positions there are the Flash Bets from BetOnMarkets.com. Most of the interest in these is centred on the two minute trades, although clients can opt for slightly longer term exposures of up to quarter of an hour.

Mike Wright, a director at the company, says that the short-term flash bets are proving really popular. ‘We currently offer flash bets on the major currency pairs and the oil price, but are aiming to extend the coverage to include the main stock market indices.’

The Flash Bets are simple to understand and completely transparent. For example, a bet to win £100 if USD/GBP rises over the next two minutes would cost £50, which reflects the 50:50 chance of the market going up. This would pay out £100 – namely a £50 profit equivalent to a 100% return on the stake – as long as the first tick after the end of the bet is higher than the first tick after the start.

According to Wright, people seem to be using technical analysis to identify the direction of the short-term trend and then backing the fact that this will continue. ‘The flash trades are the fairest in the industry as there is no spread and no commission,’ he says. ‘The two minute flashes are the most popular with some clients betting the maximum of £5,000 and some of them winning quite a lot of money.’

All or nothing

Binary bets were originally created by the spread betting company IG Index and its sister service BinaryBet.com. These work in a slightly different way to the fixed odds sites as the bets are all pre-defined, an example being a binary on the FTSE to rise over the day. A client could buy this prior to the open or they could wait and trade it in running using the live, continuously

updated price.

The all-or-nothing nature of a binary makes it very similar to buying an option and indeed the cost is calculated using a variation of the Black and Scholes options pricing model. This essentially works out the probability of the position expiring successful.

All of IG’s binary bets are defined to settle at 100 if they succeed and 0 if they fail. This means that when buying ahead of the open the mid point of the price will always be 50 – reflecting the 50:50 chance of the market rising – with the company making its money by wrapping around a bid offer spread.

Once a binary has opened the cost will mostly be governed by the options pricing model, with the main variables being where the market is trading in relation to the strike price and how volatile it is likely to be over the time frame in question. This will tend to produce more dramatic movements than in the underlying, particularly as a bet nears expiry, which makes it ideal for trading reversals.

A few days ago when the FTSE was down 50 at 12.45 pm, the bet on the index to finish the day up was trading at ten. This represented an opportunity to make a possible 90-point profit while only risking the initial cost of ten. An early sign of a positive opening on Wall Street would have been enough to produce a quick gain with limited downside.

Tim Hughes, head of sales trading at IG Index, says that the up/down binaries are a good bet to take in the sort of normal trading conditions associated with the period before the credit crunch.

‘When prices are only slightly more volatile than normal, a large early move can render the binary something of a done deal, as the chance of the market reversing is pretty slim. They are much more interesting in the highly volatile conditions we have seen this year, when an early 80-point move on the FTSE could still conceivably turn around before the close.’

Those who want to trade the binaries can do so ahead of the open or at any time that the bet is in running. This would enable them to wait until they spot a potential reversal, or to get in early and then close out before the bet expires so as to take profits or cap a loss.

‘As a concept the binaries have proved hugely successful and it is a great benefit in the current volatile conditions to be able to trade, safe in the knowledge that the maximum loss is fixed from the outset,’ says Hughes.

Positive sentiment

There have been some tentative signs that investors may be regaining their confidence. When the FTSE touched the 6,000 level on 7 April for example it marked a 600-point increase from the lows in mid March.

Ryan Kneale, a market analyst at BetsForTraders.com, says that sentiment seems to have turned with a lot more people now betting on the markets to rise. ‘The best sentiment indicator at the moment is the banking sector. These stocks have been hit hard as a result of the fallout from the sub-prime crisis, but it appears that investors may be beginning to think that the worst is over.’

There are lots of ways of making money from a recovery in the markets but one of the most direct is to open a binary bet on a banking stock. For example, when Barclays was trading at 471p, a bet at BetsForTraders.com to win £100 if in 25 days it closes above 523p was recently priced at £28.56. This represented a potential return of 250% on the stake.

‘Fixed odds bets are a simple concept that serves to democratise the financial markets,’ says Kneale. ‘We have a lot of clients who come on to our books that don’t know anything about the stock market, but that doesn’t stop some of them doing extremely well.’

The risk with a binary on a market to rise is that if the price closes lower the client would lose their stake. One way to get round this ‘all or nothing’ approach is to lock in any gains by using a ‘time-switch’ from BetsForTraders.com. These are a bit more complicated than an up or down binary, but they are excellent for taking a directional view of the market in volatile conditions. This is because they act like of a series of binaries with the gain locked in each time the client is right.

For instance, someone who is positive on Barclays could open a time-switch that would pay out £50 at the end of each of the next five five-day intervals that the share price ends above 523p. This bet was recently priced at £68 and would have produced a maximum pay out of £250, although the trader would have only needed to be right at the end of two of the five intervals to make an overall profit.

New kid on the block

The latest company to offer fixed odds financial bets is Betbrokersbinaries.com, which went live on 7 April. Its chairman, Wayne Lochner, says that the main reason why people should consider using this type of service is to be able to trade ‘off balance sheet’ without the potential unlimited downside risk of a spread bet.

‘Binaries are a unique transaction offering the potential benefits of a spread bet while limiting one’s exposure. The slider bar interface is a clever way for someone to tailor the trade or bet to meet their exact requirements.’

The interface works in the same way as that used by BetsForTraders.com, with people able to use the slider bars to build their own bets. Traders simply drag the cursors across the screen to set the strike price, the expiry and the pay out amount. As they do so the price of the bet updates in real-time to reflect the changing parameters and what is happening on the markets. Once they are happy with the result they simply have to click on the button to place the trade.