Binary Options 101
“As betting markets become more sophisticated (epitomized by the advent of specialist sports hedge funds) the crossover between sports betting and financial trading will intensify.” — Hamish Raw
The rise of binary options
We believe binary options are the next rock-star derivatives due for mass adoption because of it’s powerful and easy-to-grasp design as a financial instrument.
Binary options a.k.a fixed odd bets have been historically underappreciated by traditional finance, probably due to its speculative nature and the simplicity of the model.
We prefer to think of it as an elegant instrument with a perfect fit for long-tail P2P markets.
Especially if those markets are permissionless, unlocking many possibilities…
But let’s get back on track.
Why binary options?
Binary options have some ingrained properties (or features) that make them a great contender to the most popular derivative instrument.
- Easy to understand and relatable model (sports betting).
- Limited risk environment with capped downside (no risk of liquidation on long calls).
- Near expiry a great amount of leverage.
- Flexibility to customize bets and create markets.
- A varied offer of events that can be speculated upon, including traditional financial instruments, crypto assets, and sports betting.
Also, it enables all potential losses to be calculated at the start of the trade which is great for those that prefer tighter risk management.
Binary options structure
One feature of binaries is that at expiry, bets have a discontinuous distribution. In simple terms, this means that there is a “gap” between winning and losing with no in-between.
You either win or lose and settle your bet at either 1 or zero per binary options contract.
We’ll walk through some examples.
Sidenote: Binaries whose condition is for the result to be “above” a defined price are sometimes referred to as “upbets”. In most circumstances, the reverse of the upbet is referred to as “downbet”.
Let’s take a look at this graph representing the price of a binary option contract, an upbet, where the trader went LONG on the YES option for this example asset to be above 101 USD at strike date.
The possible scenarios when the strike date hits:
1) The underlying asset is above 101 USD (“in the money”), making the upbet a winner and giving it a value of 1.
2) Alternatively, if the underlying asset is below 101 USD, then the bet has lost having no value. This is also called “out of the money”.
There is a third, very rare, case when the underlying finishes exactly at the strike price on strike date. The current smart contract logic supports resolving markets in favor of long options for cases where the underlying price is strictly equal to the strike price to two decimal points.
It’s important to note that the price of the underlying can be above the strike price at any time (in the case of an upbet) or below the strike price (in the case of a downbet), but it’ll only count for the settlement of the bet at the strike date. Not before, not after.
Since the price of a binary option is constrained by the limits of 0 and 1, then you can easily calculate your expected win or loss at the inception of the trade.
Let’s do that so it’s extra clear how to do it.
Binary options profit & loss calculations
People that purchase binary options can only lose the amount they spent on the premium.
No risk of liquidations here, folks.
If we take the previous example and imagine the trader paid 30c per token on that upbet, and he bought 1000, then the maximum he can lose is what he paid, 300 USD (-100% ROI).
The potential profit is also capped, if we assume no trading, at 700 USD (233% ROI).
If we come back to the possible scenarios and we add the potential profit and losses we get these outcomes:
1) If the underlying is above 101 USD at the strike date, then the trader generates a 700 USD profit. Spending 300 USD for the options then winning 1000 USD when exercising it.
2) Conversely, if the underlying is below 101 USD at the strike date, then the trader losses 300 USD, which he invested originally.
Sounds simple enough, right?
From the binary options platform perspective, having a combination of homogenous limited-risk instruments to offer, and zero credit facility ensures there aren’t any user account defaults.
This is big because it greatly diminishes the platform’s financial risk while offering innovative speculation instruments.
That’s great news for future Thales token holders.
We are hyped and moving forward every day to bring the Thales platform live.
We have a post coming soon detailing our new model for minting and trading binary options so stay tuned!
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Stay around, this is just the beginning of an epic journey!