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.
