Wednesday, August 10, 2016

Cofnas, Trading Binary Options, 2d ed.

Binary options are simple trading instruments that are designed to offer an attractive alternative for the directional trader with a small account. As Abe Cofnas explains in the second edition of Trading Binary Options: Strategies and Tactics (Bloomberg/ Wiley, 2016), the trader makes a straightforward bet: that the settled price of an underlying market will be at, above, or below a target strike barrier by a defined future time. If he’s right, he gets $100; if he’s wrong, he gets nothing. At least that’s the way it works on Nadex (North American Derivatives Exchange).

Traders who have shied away from options because they seem overly complicated may be relieved to learn that understanding the Greeks is not essential in the world of binary options. Yes, market makers use them to price the binaries and Cofnas even introduces the reader to volatility smiles, but the trader’s major decisions are whether to buy or sell binary options, at what strike price, and for what duration. How much does he think the market will move in a given length of time and in what direction?

Of course, getting the direction, magnitude, and timing of a short-term trade (weekly, daily, and a selection of intraday expiries) right is a daunting task. Cofnas therefore devotes four chapters to tools the binary options trader can use to improve his skills: sentiment analysis, tracking fundamental forces that impact markets, technical analysis, and volatility tools.

He then describes in some detail seven major binary option trading strategies that can be used to respond to global market-related events: in-the-money, deep-in-the-money, at-the-money, out-of-the-money, deep-out-of-the-money, range trades, and breakout trades. He offers, among others, examples of gold and EUR/USD trades during the Greek debt crisis, a crude oil play at the time of revolts in Tunisia and Egypt, a GBP/USD trade just before the referendum on Scottish independence, and a USD/CHF trade the week of U.S. congressional elections. He draws these examples from trading alerts he sent out in Agora Financial’s Strategic Currency Trading newsletter. Cofnas also devotes a full chapter to using binary options to trade the non-farm payroll report.

The book concludes with chapters on risk management, metrics for improving trading performance, performance tools and training for improving trading, and a 51-question quiz.

Traders who want to get a feel for binary options can create a free paper trading account at Nadex. If they have experience trading other instruments they will most likely be struck by the incredibly wide bid/ask spreads here. For instance, whereas the front-month crude oil futures normally have a penny-wide spread and options on CL have spreads of about two to seven cents, the day I checked crude oil binary spreads on Nadex, on a weekly contract with two days left, they ranged from $5.25 to $7.00, with bids from $0.50 to $93.50 and offers from $5.75 to $98.75. And in contrast to Cantor, NYSE, and CBOE, Nadex takes the other side of the trade. The trade-off here, as Cofnas points out, is the potential lack of liquidity on the “true exchanges.”

Cofnas’s book is useful to anyone considering adding binary options to his trading portfolio. As, of course, is trying out some strategies in a paper account to see whether they are solid enough to overcome the wide spreads and, in the case of Nadex, to beat the house.

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