Binary Bets

Scripophilist

Active member
221 7
I've been "doing it" succesfully on Betfair for quite a while and prefer that format because the spreads are narrow and there can be no dispute on the win. That said it tends to be farily illquid in comparison to IG who must hedge (at least a little).

That said I used to be an IG shareholder and the view was that on average punters where no better than random and therefore they tended not to hedge at all. In which case it's you vs IG.
 

Scripophilist

Active member
221 7
Of course this strategy would rely on there being a liquid market of punters or else IG would be horribly exposed.

I noticed they widened there spread a fair bit from where they started. I used to get 3 points on the DOW but most of the time its 6 now.
 

donaldduke

Experienced member
1,665 257
Robertral,

You been quoting these formulas for some time now.. Its
a bit hard for us mere mortals (although i did get an A in maths
at Olevel) to grasp..

What would be more usefull would be a real worked example:

Lets say the the Dow is trading up 20 points from the open and
IG offer a binary bet for Dow to close up more than 50 points.
They quote a market 25(bid)-30(offer). Its two hours before the
close.

I buy at 30 offer expecting the Dow to close above 50 points from the open, i will make 70 if it does lose 30 if doesnt.

How would IG hedge this specific bet using options...

Or if its easier to explain a range bet like 50-60 points
that would be fine too.
 

Robertral

Well-known member
446 4
donaldduke said:
Robertral,

You been quoting these formulas for some time now.. Its
a bit hard for us mere mortals (although i did get an A in maths
at Olevel) to grasp..

What would be more usefull would be a real worked example:

Lets say the the Dow is trading up 20 points from the open and
IG offer a binary bet for Dow to close up more than 50 points.
They quote a market 25(bid)-30(offer). Its two hours before the
close.

I buy at 30 offer expecting the Dow to close above 50 points from the open, i will make 70 if it does lose 30 if doesnt.

How would IG hedge this specific bet using options...

Or if its easier to explain a range bet like 50-60 points
that would be fine too.

To start with the formula I quoted before replicates a tight bull spread.

Think about a bull spread. If the strikes are close together then this will give you a binary?!?!?!?

My equation Binary = (1/k) * [Call(X+k) - Call(X)] is exactly the same. k is just the min difference between strikes for a given market.

[As an aside you can take the limit of k to 0 and incorporate the vol smile in there.....]

Lets say that the binary is for a market F an we want to price the binary with a strike of 105 using the following formula

Binary = (1/k) * [Call(X+k) - Call(X)]

where X = 100 (the binary strike, depending on how you derive the binary)
k is the difference in strike prices....
the 1/k multiplier is to normalise the payoff to 1 if S>X...just draw a payoff diagram for Call(X+k) - Call(X) and you will see you have to divide by the strike difference to get you 1 payoff.

I.e the options market has strikes of 95 100 105...I can replicate a binary by buying a 100 call and selling a 105 call....

Thing is with the above if the market is between 100 and 105 I have pin risk as I'm not gonna get my 0 or 1 pay off....I'm gonna get something in between…...this is where the lottery comes into play for the MM.....i.e sell something for 100 when it costs you 95....
It all depends on how volatile your market is

I can't give you exact numers for the sheaaaat you have quotes as I dont know the other parameters but I hope the following helps...
With the range binaries you have to use a truncated lognormal integral to price, using the lower and upper bounds (i,.e your range binary limits)...if you know stoch calc this will ring a bell...it's quite hard to write this stuff in this format...

exp(-rT)*E[a>S_T>b | S_t<T ] = ????

If it's pure pricing you want I can write you up a word document how price binaries and sheaaaat

For MM hedging on this sheaaaatt it all depends on the flow….you might get roughly equal amounts of punters buying options on each range within the package, thus it’s easy to hedge the books with a simply tight bull spread. It depends on the flow. Otherwise the MM would take a global view of the book.

Please give me a PM or whatever if this doesn’t make any sense, as I’m very happy to write a word doc to explain this stuff
 

anley

Senior member
2,730 229
Roberttral

Very impressive but I doubt the spread betters would be using options to hedge especially on the smaller timeframe bets.

Your workings don't take into account the lack of liquidity and their inherently large bid-offer spreads.

If I was making a market with binaries I'd keep it very simple because with a 5% bid-offer spread there's plenty of money to be made without getting fancy.
 

donaldduke

Experienced member
1,665 257
Robertval,

The theory looks really impressive, but in practice do real world
options exist that could be used, i mean i could be wrong but
daily options dont exists in the real world as far as i know and
monthly options wouldnt be volatile enough to used for hedging..
 

stevespray

Experienced member
1,289 154
Good thread guys, I tried to raise the subject of “Binary Bets” a few months back but got very little response, it appears that there is a little more interest now so I’d be happy to share some thoughts / research.

Firstly, from the research I have carried out it appears that the “Binary Bets” (BB’s) are price through a method of simple probabilities based on previous market activity. I’ll try and explain. Obviously the prices we see may have several factors taken into consideration but the main considerations are clearly “what are the odds of the particular event in question occurring ?” and “how long until expiry”. As I write (13.55pm) FTSE is up about 25 and IG are quoting 94.4/97.6 for the “FTSE to finish up” binary. The mid is therefore 96.5 so therefore I think we can assume that IG feel that from the current position the FTSE would finish up on 96.5 days out of 100. The exact odds may of course be skewed slightly by the positions that customers already have having a direct influence on the quoted price but the essence of IG’s view is clear. It’s quite straight forward really. From what I can gather it would be very hard to hedge these bets into the underlying markets. The spread on options would be massive and it would require the company to trade in and out of them on an intra-day basis, it just isn’t cost effective. I would have thought that IG would shoulder the whole risk themselves, if they don’t then I’d love to know how the hedge the risk in such a short term timeframe.

Secondly, when it comes to trading the BB’s I would have thought that it would pay to look for opportunities where there is a high chance of disruption in IG’s probability maps. If they are indeed based on history (what else can they be based on) then they need to calculate several parameters in order to produce the correctly balanced price. BB’s are obviously priced in a very similar manner to the pricing used in options and therefore volatility plays a very big factor especially when there is a high proportion of time still left until final expiry. The spreadbet company therefore have to calculate a volatility factor to use in their calculations and one imagines that this is a simple historical calculation based on the market movement over the last X number of days – a form of moving average if you will. If we can therefore spot times when we might be able to determine that volatility has a high likelihood of being higher or lower than normal then sometimes trading opportunities reveal themselves. For example, a few Mondays back it was Presidents Day in the US and the markets were mostly closed. I suggested to a couple of people that the FTSE binary bets would be worth playing on that day for the simple reason that the FTSE was very unlikely to move to any great degree between 1.30pm and its expiry at 4.30pm based on the fact that the US was closed. Low and behold that afternoon the FTSE kept a fairly narrow range and it was easy to pick off a few nice trades. Likewise when there is very sensitive data due, the likelihood of volatility increase. This means that we can do the reverse. We can trade the fact that there is a drastic increase in the chances of a large move. For example that FTSE I wrote about above, its 94.4 bid, if we had some economic data due that the market was hanging on then the chances of the FTSE not finishing positive increase somewhat and we are only risking 5.6 points to bet on it.
It’s my opinion that the Binary Bets are priced using averages to calculate volitility. If we deliberately attempt to trade during times when the short term volatility has a high likelihood of moving away from its average then we seriously increase our chances of making money because there is a good chance that our bookmaker hasn’t factored it in.

Steve.
 

Robertral

Well-known member
446 4
donaldduke said:
Robertval,

The theory looks really impressive, but in practice do real world
options exist that could be used, i mean i could be wrong but
daily options dont exists in the real world as far as i know and
monthly options wouldnt be volatile enough to used for hedging..

Hedge the book as whole..i.e the delta, gamma....i.e strikes that are coming off every hour, every day etc wont really effect the book is there is a large diverse flow...hedge as a whole..my formulee were for repliation and can be used as a hedge but the MM would hedge the book as a whole using the underlying or whatever....

I can offer the following equation

Binary = exp(-r*T)*N(d1) + vega*vol_skew

The above takes into account the vol smile etc....

Does that throw anymore light on pricing??? the MM can always increase the vol skew in uncertain times. Use a GARCH to predict vol maybe?!?!?!? predict the vol surface etc....give it high vols jsut to cover their backs

edit....so yeah the above part N(d1) just gives the prob of the underlying going above the strike
 
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anley

Senior member
2,730 229
Robert

Although we like your input I feel that I speak for the majority of the board and say that you are going so far over our heads that you're out of sight!

I only took maths O-Level.........

I'm sure you make some excellent points though, now go and use your brain to make a killing.

Steve, good forensics on the Binaries.
 

Robertral

Well-known member
446 4
k I might be a little tech for this forum but it's not going out of sight...the above stuff is basic knowledge on the floor and is used all the time. Thought it might help in understanding where the prices come from
 

anley

Senior member
2,730 229
Depends which floor, options of course but not for futures/spread bets/stocks/cfds etc which most people here use.

You also don't have to have maths o-level knowledge to make good money in this game. Many have made fortunes without and many have never made a penny with it. Of course the reverse is true as well.

Go into one of the arcades and see if there's any correlation between the boys making the good money and their knowledge of the above.
 

law

Newbie
4 0
hi there
just wondering if anyone has observed the following?
Does the binary bet for the daily market to finish up (FTSE & DOW) ever open at 20-30 range, with the market condition being an uptrend and the previous day closed down?
Anybody who could help would be greatly appreciated.
THanks
 
 
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