A binary option is a financial exotic option in which the payoff is either some fixed monetary amount or nothing at all. The two main types of binary options are the cash-or-nothing binary option and the asset-or-nothing binary option; the former pays some fixed amount of cash if the option expires in-the-money while the latter pays the value of the underlying security. They are called all-or-nothing options, digital options, fixed return options. While binary options may be used in theoretical asset pricing, they are prone to fraud in their applications and hence banned by regulators in many jurisdictions as a form of gambling. Many binary option outlets have been exposed as fraudulent; the U. S. FBI is investigating binary option scams throughout the world, the Israeli police have tied the industry to criminal syndicates; the European Securities and Markets Authority have banned retail binary options trading. ASIC considers binary options as a “high-risk” and “unpredictable” investment option.
The FBI estimates. The use of the names of famous and respectable people such as Richard Branson to encourage people to buy fake "investments" is frequent and increasing. Articles published in the Times of Israel newspaper explain the fraud in detail, using the experience of former insiders such as a job-seeker recruited by a fake binary options broker, told to "leave conscience at the door". Following an investigation by the Times of Israel, Israel's cabinet approved a ban on sale of binary options in June 2017, a law banning the products was approved by the Knesset in October 2017. On January 30, 2018, Facebook banned advertisements for binary options trading as well as for cryptocurrencies and initial coin offerings. Google and Twitter announced similar bans in the following weeks. Binary options "are based on a simple'yes' or'no' proposition: Will an underlying asset be above a certain price at a certain time?" Traders place wagers as to whether that will not happen. If a customer believes the price of an underlying asset will be above a certain price at a set time, the trader buys the binary option, but if he or she believes it will be below that price, they sell the option.
In the U. S. exchanges, the price of a binary is always under $100. Investopedia described the binary options trading process in the U. S. thus: binary may be trading at $42.50 and $44.50 at 1 p.m. If you buy the binary option right you will pay $44.50, if you decide to sell right you'll sell at $42.50. Let's assume you decide to buy at $44.50. If at 1:30 p.m. the price of gold is above $1,250, your option expires and it becomes worth $100. You make a profit of $100 - $44.50 = $55.50. This is called being "in the money." But if the price of gold is below $1,250 at 1:30 p.m. the option expires at $0. Therefore you lose the $44.50 invested. This is called being "out of the money." The bid and offer fluctuate. You can close your position at any time before expiry to lock in a reduce a loss. In the U. S. every binary option settles at $0, $100 if the bet is correct, 0 if it is not. In the online binary options industry, where the contracts are sold by a broker to a customer in an OTC manner, a different option pricing model is used.
Brokers sell binary options at a fixed price and offer some fixed percentage return in case of in-the-money settlement. Some brokers offer a sort of out-of-money reward to a losing customer. For example, with a win reward of 80%, out-of-money reward of 5%, the option price of $100, two scenarios are possible. In-the-money settlement pays back the option price of $100 and the reward of $80. In case of loss, the option price is not returned but the out-of-money reward of $5 is granted to the customer. On non-regulated platforms, client money is not kept in a trust account, as required by government financial regulation, transactions are not monitored by third parties in order to ensure fair play. Binary options are considered a form of gambling rather than investment because of their negative cumulative payout and because they are advertised as requiring little or no knowledge of the markets. Gordon Pape, writing in Forbes.com in 2010, called binary options websites "gambling sites and simple", said "this sort of thing can become addictive... no one, no matter how knowledgeable, can predict what a stock or commodity will do within a short time frame".
Pape observed that binary options are poor from a gambling standpoint as well because of the excessive "house edge". One online binary options site paid $71 for each successful $100 trade. "If you lose, you get back $15. Let's say you win 545 of them. Your profit is $38,695, but your 455 losses will cost you $38,675. In other words, you must win 54.5% of the time just to break even". The U. S. Commodity Futures Trading Commission warns that "some binary options Internet-based trading platforms may overstate the average return on investment by advertising a higher average return on investment than a customer should expect given the payout structure." In the Black–Scholes model, the price of the option can be found by the formulas below. In fact, the Black–Scholes formula for the price of a vanilla call option can be interpreted by decomposing a call option into an asset-or-nothing call option minus a cash-or-nothing call option, for a put – the binary options are easier to analyze, correspond to the two terms in the Black–Scholes formula.
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In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, is simply called the "underlying." Derivatives can be used for a number of purposes, including insuring against price movements, increasing exposure to price movements for speculation or getting access to otherwise hard-to-trade assets or markets. Some of the more common derivatives include forwards, options and variations of these such as synthetic collateralized debt obligations and credit default swaps. Most derivatives are traded over-the-counter or on an exchange such as the New York Stock Exchange, while most insurance contracts have developed into a separate industry. In the United States, after the financial crisis of 2007–2009, there has been increased pressure to move derivatives to trade on exchanges. Derivatives are one of the three main categories of financial instruments, the other two being stocks and debt.
The oldest example of a derivative in history, attested to by Aristotle, is thought to be a contract transaction of olives, entered into by ancient Greek philosopher Thales, who made a profit in the exchange. Bucket shops, outlawed a century ago, are a more recent historical example. Derivatives are contracts between two parties that specify conditions under which payments are to be made between the parties; the assets include commodities, bonds, interest rates and currencies, but they can be other derivatives, which adds another layer of complexity to proper valuation. The components of a firm's capital structure, e.g. bonds and stock, can be considered derivatives, more options, with the underlying being the firm's assets, but this is unusual outside of technical contexts. From the economic point of view, financial derivatives are cash flows, that are conditioned stochastically and discounted to present value; the market risk inherent in the underlying asset is attached to the financial derivative through contractual agreements and hence can be traded separately.
The underlying asset does not have to be acquired. Derivatives therefore allow the breakup of ownership and participation in the market value of an asset; this provides a considerable amount of freedom regarding the contract design. That contractual freedom allows derivative designers to modify the participation in the performance of the underlying asset arbitrarily. Thus, the participation in the market value of the underlying can be weaker, stronger, or implemented as inverse. Hence the market price risk of the underlying asset can be controlled in every situation. There are two groups of derivative contracts: the traded over-the-counter derivatives such as swaps that do not go through an exchange or other intermediary, exchange-traded derivatives that are traded through specialized derivatives exchanges or other exchanges. Derivatives are more common in the modern era. One of the oldest derivatives is rice futures, which have been traded on the Dojima Rice Exchange since the eighteenth century.
Derivatives are broadly categorized by the relationship between the underlying asset and the derivative. Derivatives may broadly be categorized as "lock" or "option" products. Lock products obligate the contractual parties to the terms over the life of the contract. Option products provide the buyer the right, but not the obligation to enter the contract under the terms specified. Derivatives can be used either for speculation; this distinction is important because the former is a prudent aspect of operations and financial management for many firms across many industries. Along with many other financial products and services, derivatives reform is an element of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010; the Act delegated many rule-making details of regulatory oversight to the Commodity Futures Trading Commission and those details are not finalized nor implemented as of late 2012. To give an idea of the size of the derivative market, The Economist has reported that as of June 2011, the over-the-counter derivatives market amounted to $700 trillion, the size of the market traded on exchanges totaled an additional $83 trillion.
For the fourth quarter 2017 the European Securities Market Authority estimated the size of European derivatives market at a size of €660 trillion with 74 million outstanding contracts. However, these are "notional" values, some economists say that this value exaggerates the market value and the true credit risk faced by the parties involved. For example, in 2010, while the aggregate of OTC derivatives exceeded $600 trillion, the value of the market was estimated much lower, at $21 trillion; the credit risk equivalent of the derivative contracts was estimated at $3.3 trillion. Still, eve
Iron butterfly (options strategy)
In finance an iron butterfly known as the ironfly, is the name of an advanced, neutral-outlook, options trading strategy that involves buying and holding four different options at three different strike prices. It is a limited-risk, limited-profit trading strategy, structured for a larger probability of earning smaller limited profit when the underlying stock is perceived to have a low volatility. Ironfly = Δ × − butterfly A short iron butterfly option strategy will attain maximum profit when the price of the underlying asset at expiration is equal to the strike price at which the call and put options are sold; the trader will receive the net credit of entering the trade when the options all expire worthless. A short iron butterfly option strategy consists of the following options: Long one out-of-the-money put: strike price of X − a Short one at-the-money put: strike price of X Short one at-the-money call: strike price of X Long one out-of-the-money call: strike price of X + awhere X = the spot price and a > 0.
A long iron butterfly will attain maximum losses when the stock price falls at or below the lower strike price of the put or rises above or equal to the higher strike of the call purchased. The difference in strike price between the calls or puts subtracted by the premium received when entering the trade is the maximum loss accepted; the formula for calculating maximum loss is given below: Max Loss = Strike Price of Long Call − Strike Price of Short Call − Premium Max Loss Occurs When Price of Underlying >= Strike Price of Long Call OR Price of Underlying <= Strike Price of Long Put Two break points are produced with the iron butterfly strategy. Using the following formulas, the break points can be calculated: Upper Breakeven Point = Strike Price of Short Call + Net Premium Received Lower Breakeven Point = Strike Price of Short Put − Net Premium Received Buy XYZ 140 Put for $2.00 Sell XYZ 145 Put for $4.00 Sell XYZ 145 Call for $4.00 Buy XYZ 150 Call for $3.00 Max. Profit = Net Credit = $4.00 + $4.00 − $2.00 − $3.00 = $3.00 Max.
Risk = Margin = Difference in Strikes − Net Credit = $5.00 − $3.00 = $2.00 Upper Break Even = Short Call Strike + Net Credit = $145 + $3.00= $148.00 Lower Break Even = Short Put Strike − Net Credit = $145 − $3.00 = $142.00 Max. Return = Net Credit ÷ Margin = $3.00 ÷ $2.00 = 150%. A long iron butterfly option strategy will attain maximum profit when the price of the underlying asset at expiration is greater than the strike price set by the out-of-the-money put and less than the strike price set by the out-of-the-money call; the trader will receive the difference between the options that expire in the money, while paying the premium on the options that expire out of the money. McMillan, Lawrence G.. Options as a Strategic Investment. New York: New York Institute of Finance. ISBN 0-7352-0197-8
In finance, volatility is the degree of variation of a trading price series over time as measured by the standard deviation of logarithmic returns. Historic volatility measures a time series of past market prices. Implied volatility looks forward in time, being derived from the market price of a market-traded derivative. Volatility as described here refers to the actual volatility, more specifically: actual current volatility of a financial instrument for a specified period, based on historical prices over the specified period with the last observation the most recent price. Actual historical volatility which refers to the volatility of a financial instrument over a specified period but with the last observation on a date in the past near synonymous is realized volatility, the square root of the realized variance, in turn calculated using the sum of squared returns divided by the number of observations. Actual future volatility which refers to the volatility of a financial instrument over a specified period starting at the current time and ending at a future date Now turning to implied volatility, we have: historical implied volatility which refers to the implied volatility observed from historical prices of the financial instrument current implied volatility which refers to the implied volatility observed from current prices of the financial instrument future implied volatility which refers to the implied volatility observed from future prices of the financial instrumentFor a financial instrument whose price follows a Gaussian random walk, or Wiener process, the width of the distribution increases as time increases.
This is because there is an increasing probability that the instrument's price will be farther away from the initial price as time increases. However, rather than increase linearly, the volatility increases with the square-root of time as time increases, because some fluctuations are expected to cancel each other out, so the most deviation after twice the time will not be twice the distance from zero. Since observed price changes do not follow Gaussian distributions, others such as the Lévy distribution are used; these can capture attributes such as "fat tails". Volatility is a statistical measure of dispersion around the average of any random variable such as market parameters etc. For any fund that evolves randomly with time, the square of volatility is the variance of the sum of infinitely many instantaneous rates of return, each taken over the nonoverlapping, infinitesimal periods that make up a single unit of time. Thus, "annualized" volatility σannually is the standard deviation of an instrument's yearly logarithmic returns.
The generalized volatility σT for time horizon T in years is expressed as: σ T = σ annually T. Therefore, if the daily logarithmic returns of a stock have a standard deviation of σdaily and the time period of returns is P in trading days, the annualized volatility is σ P = σ daily P. A common assumption is. If σdaily = 0.01, the annualized volatility is σ annually = 0.01 252 = 0.1587. The monthly volatility would be σ monthly = 0.1587 1 12 = 0.0458. Σ monthly = 0.01 252 12 = 0.0458. The formulas used above to convert returns or volatility measures from one time period to another assume a particular underlying model or process; these formulas are accurate extrapolations of a random walk, or Wiener process, whose steps have finite variance. However, more for natural stochastic processes, the precise relationship between volatility measures for different time periods is more complicated; some use the Lévy stability exponent α to extrapolate natural processes: σ T = T 1 / α σ. If α = 2 you get the Wiener process scaling relation, but some people believe α < 2 for financial activities such as stocks, indexes and so on.
This was discovered by Benoît Mandelbrot, who looked at cotton prices and found that they followed a Lévy alpha-stable distribution with α = 1.7. Much research has been devoted to modeling and forecasting the volatility of financial returns, yet few theoretical models explain how volatility comes to exist in the first place. Roll shows. Glosten and Milgrom shows that at least one source of volatility can be explained by the liquidity provision process; when market makers infer the possibility of adverse selection, they adjust their trading ranges, which in turn increases the band of price oscillation. Investors care about volatility for at least eight reasons: The wider the swings in an investment's price, the harder it is to not worry.
Option strategies are the simultaneous, mixed, buying or selling of one or more options that differ in one or more of the options' variables. Call options known as calls, give the buyer a right to buy a particular stock at that option's strike price. Conversely, put options known as puts, give the buyer the right to sell a particular stock at the option's strike price; this is done to gain exposure to a specific type of opportunity or risk while eliminating other risks as part of a trading strategy. A straightforward strategy might be the buying or selling of a single option, however option strategies refer to a combination of simultaneous buying and or selling of options. Options strategies allow traders to profit from movements in the underlying assets based on market sentiment. In the case of neutral strategies, they can be further classified into those that are bullish on volatility, measured by the lowercase Greek letter sigma, those that are bearish on volatility. Traders can profit off time decay, measured by the uppercase Greek letter theta, when the stock market has low volatility.
The option positions used can be long and/or short positions in puts. These strategies are used in speculation, negative as personal behavior and for the expected damage to the real economy. Bullish options strategies are employed when the options trader expects the underlying stock price to move upwards, they can use Theta with a bullish/Bearish combo called a Calendar Spread and not rely on stock movement. The trader can just assess how high the stock price can go and the time frame in which the rally will occur in order to select the optimum trading strategy for just buying a bullish option; the most bullish of options trading strategies is buying a call option used by most options traders. The stock market is always moving some how. It's up to the stock trader to figure. Moderately bullish options traders set a target price for the bull run and utilize bull spreads to reduce cost or eliminate risk altogether. There is limited risk trading options by using the appropriate strategy. While maximum profit is capped for some of these strategies, they cost less to employ for a given nominal amount of exposure.
There are options that have unlimited potential to the up or down side with limited risk if done correctly. The bull call spread and the bull put. Mildly bullish trading strategies are options that make money as long as the underlying stock price does not go down by the option's expiration date; these strategies may provide downside protection as well. Writing out-of-the-money covered calls is a good example of such a strategy. However, Covered Calls require the trader to buy actual stock in the end which needs to be taken into account for margin; this is. The trader is buying an option to cover the stock you have purchased; this is. The stock market is much more than ups and downs, selling and puts. Options give the trader flexibility to make a change and career out of what some call a dangerous or rigid market or profession. Think of options as the building blocks of strategies for the market. Options have been around since the market started, they just did not have their own spotlight until recently.
Bearish options strategies are employed when the options trader expects the underlying stock price to move downwards. It is necessary to assess how low the stock price can go and the time frame in which the decline will happen in order to select the optimum trading strategy. Selling a Bearish option is another type of strategy that gives the trader a "credit"; this does require a margin account. The most bearish of options trading strategies is the simple put buying or selling strategy utilized by most options traders. Stock can make steep downward moves. Moderately bearish options traders set a target price for the expected decline and utilize bear spreads to reduce cost; this strategy can have unlimited amount of profit and limited risk. The bear call spread and the bear put. Mildly bearish trading strategies are options strategies that make money as long as the underlying stock price does not go up by the options expiration date. However, you can add more options to the current position and move to a more advance position that relies on Time Decay "Theta".
These strategies may provide a small upside protection as well. In general, bearish strategies yield profit with less risk of loss. Neutral strategies in options trading are employed when the options trader does not know whether the underlying stock price will rise or fall. Known as non-directional strategies, they are so named because the potential to profit does not depend on whether the underlying stock price will go upwards. Rather, the correct neutral strategy to employ depends on the expected volatility of the underlying stock price. Examples of neutral strategies are: Guts - sell a pair of ITM put and call. Long butterfly spreads use four option contracts with the same expiration but three different strike prices to create a range of prices the strategy can profit from. Straddle - an options strategy in which the investor holds a position in both a call and put with the same strike price and expiration date, pa
In finance, an option is a contract which gives the buyer the right, but not the obligation, to buy or sell an underlying asset or instrument at a specified strike price prior to or on a specified date, depending on the form of the option. The strike price may be set by reference to the spot price of the underlying security or commodity on the day an option is taken out, or it may be fixed at a discount or at a premium; the seller has the corresponding obligation to fulfill the transaction – to sell or buy – if the buyer "exercises" the option. An option that conveys to the owner the right to buy at a specific price is referred to as a call. Both are traded, but the call option is more discussed; the seller may grant an option to a buyer as part of another transaction, such as a share issue or as part of an employee incentive scheme, otherwise a buyer would pay a premium to the seller for the option. A call option would be exercised only when the strike price is below the market value of the underlying asset, while a put option would be exercised only when the strike price is above the market value.
When an option is exercised, the cost to the buyer of the asset acquired is the strike price plus the premium, if any. When the option expiration date passes without the option being exercised, the option expires and the buyer would forfeit the premium to the seller. In any case, the premium is income to the seller, a capital loss to the buyer; the owner of an option may on-sell the option to a third party in a secondary market, in either an over-the-counter transaction or on an options exchange, depending on the option. The market price of an American-style option closely follows that of the underlying stock being the difference between the market price of the stock and the strike price of the option; the actual market price of the option may vary depending on a number of factors, such as a significant option holder may need to sell the option as the expiry date is approaching and does not have the financial resources to exercise the option, or a buyer in the market is trying to amass a large option holding.
The ownership of an option does not entitle the holder to any rights associated with the underlying asset, such as voting rights or any income from the underlying asset, such as a dividend. Contracts similar to options have been used since ancient times; the first reputed option buyer was the ancient Greek mathematician and philosopher Thales of Miletus. On a certain occasion, it was predicted that the season's olive harvest would be larger than usual, during the off-season, he acquired the right to use a number of olive presses the following spring; when spring came and the olive harvest was larger than expected he exercised his options and rented the presses out at a much higher price than he paid for his'option'. In London, puts and "refusals" first became well-known trading instruments in the 1690s during the reign of William and Mary. Privileges were options sold over the counter in nineteenth century America, with both puts and calls on shares offered by specialized dealers, their exercise price was fixed at a rounded-off market price on the day or week that the option was bought, the expiry date was three months after purchase.
They were not traded in secondary markets. In the real estate market, call options have long been used to assemble large parcels of land from separate owners. Film or theatrical producers buy the right — but not the obligation — to dramatize a specific book or script. Lines of credit give the potential borrower the right — but not the obligation — to borrow within a specified time period. Many choices, or embedded options, have traditionally been included in bond contracts. For example, many bonds are convertible into common stock at the buyer's option, or may be called at specified prices at the issuer's option. Mortgage borrowers have long had the option to repay the loan early, which corresponds to a callable bond option. Options contracts have been known for decades; the Chicago Board Options Exchange was established in 1973, which set up a regime using standardized forms and terms and trade through a guaranteed clearing house. Trading activity and academic interest has increased since then.
Today, many options are created in a standardized form and traded through clearing houses on regulated options exchanges, while other over-the-counter options are written as bilateral, customized contracts between a single buyer and seller, one or both of which may be a dealer or market-maker. Options are part of a larger class of financial instruments known as derivative products, or derivatives. A financial option is a contract between two counterparties with the terms of the option specified in a term sheet. Option contracts may be quite complicated.
In mathematical finance, the Greeks are the quantities representing the sensitivity of the price of derivatives such as options to a change in underlying parameters on which the value of an instrument or portfolio of financial instruments is dependent. The name is used. Collectively these have been called the risk sensitivities, risk measures or hedge parameters; the Greeks are vital tools in risk management. Each Greek measures the sensitivity of the value of a portfolio to a small change in a given underlying parameter, so that component risks may be treated in isolation, the portfolio rebalanced accordingly to achieve a desired exposure; the Greeks in the Black–Scholes model are easy to calculate, a desirable property of financial models, are useful for derivatives traders those who seek to hedge their portfolios from adverse changes in market conditions. For this reason, those Greeks which are useful for hedging—such as delta and vega—are well-defined for measuring changes in Price and Volatility.
Although rho is a primary input into the Black–Scholes model, the overall impact on the value of an option corresponding to changes in the risk-free interest rate is insignificant and therefore higher-order derivatives involving the risk-free interest rate are not common. The most common of the Greeks are the first order derivatives: delta, vega and rho as well as gamma, a second-order derivative of the value function; the remaining sensitivities in this list are common enough that they have common names, but this list is by no means exhaustive. The use of Greek letter names is by extension from the common finance terms alpha and beta, the use of sigma and tau in the Black–Scholes option pricing model. Several names such as ` vega' and ` zomma' sound similar to Greek letters; the names'color' and'charm' derive from the use of these terms for exotic properties of quarks in particle physics. Delta, Δ, measures the rate of change of the theoretical option value with respect to changes in the underlying asset's price.
Delta is the first derivative of the value V of the option with respect to the underlying instrument's price S. For a vanilla option, delta will be a number between 0.0 and 1.0 for a long call and 0.0 and −1.0 for a long put. The difference between the delta of a call and the delta of a put at the same strike is close to but not in general equal to one, but instead is equal to the inverse of the discount factor. By put–call parity, long a call and short a put is equivalent to a forward F, linear in the spot S, with factor the inverse of the discount factor, so the derivative dF/dS is this factor; these numbers are presented as a percentage of the total number of shares represented by the option contract. This is convenient. For example, if a portfolio of 100 American call options on XYZ each have a delta of 0.25, it will gain or lose value just like 2,500 shares of XYZ as the price changes for small price movements. The sign and percentage are dropped – the sign is implicit in the option type and the percentage is understood.
The most quoted are 25 delta put, 50 delta put/50 delta call, 25 delta call. 50 Delta put and 50 Delta call are not quite identical, due to spot and forward differing by the discount factor, but they are conflated. Delta is always negative for long puts; the total delta of a complex portfolio of positions on the same underlying asset can be calculated by taking the sum of the deltas for each individual position – delta of a portfolio is linear in the constituents. Since the delta of underlying asset is always 1.0, the trader could delta-hedge his entire position in the underlying by buying or shorting the number of shares indicated by the total delta. For example, if the delta of a portfolio of options in XYZ is +2.75, the trader would be able to delta-hedge the portfolio by selling short 2.75 shares of the underlying. This portfolio will retain its total value regardless of which direction the price of XYZ moves.. The Delta is close to, but not identical with, the percent moneyness of an option, i.e. the implied probability that the option will expire in-the-money.
For this reason some option traders use the absolute value of delta as an approximation for percent moneyness. For example, if an out-of-the-money call option has a delta of 0.15, the trader might estimate that the option has a 15% chance of expiring in-the-money. If a put contract has a delta of −0.25, the trader might expect the option to have a 25% probability of expiring in-the-money. At-the-money calls and puts have a delta of 0.5 and −0.5 wi