Mechanics of Binary One Touch Options
Mechanics of Binary Touch Options
Binary Touch Options, although categorized as exotic options, are among the simplest but most powerful investment instruments. They provide full knowledge of likely profit or loss, greater leverage, and a restricted potential loss. This article introduces the mechanics of binary touch options.
Binary touch options require a buyer to pay the seller of an option an upfront premium. The buyer then receives a fixed payout amount if a given condition is met during the lifetime of the binary option. The condition is that the prevailing spot rate will or will not trade at a particular level during the lifetime of the option. Payout of the binary depends on a spot rate level known as the barrier or the trigger.
There are two types of binary touch options:
- a) One Touch option: Generates a payout if the prevailing spot rate reaches the barrier/ trigger level any time throughout the lifetime of the option.
- b) No Touch option: Generates a payout when underlying spot rate never reaches the trigger level throughout the life of the option.
A binary touch option allows the trader to state the view that a particular spot level will or will not trade in the lifetime of the binary option.
Let us consider some examples in EUR/USD. Let us assume the spot is at 1.4400.
- Buying One Touch Option
You think that EUR/USD spot rate will move to 1.4400 during the next 2 weeks and settle on buying this One Touch option:
Expiry: 2 weeks
Payout: EUR 50,000
If the price offer for this option is 35%, you will part with an upfront premium amount of EUR 17,500 (EUR 50,000 * 35%).
- a) If you are right and 1.4400 trades in the market any time in the life of the option, you receive the EUR 50,000 payout amount.
- b) If you are wrong and 1.4400 does not trade all through the duration of the option, you do not receive the EUR 50,000 payout. You will therefore incur a loss of EUR 17,500, the amount paid as upfront premium.
- Buying No Touch Option
You think that the EUR/USD spot level will stay below 1.4400 for the next two weeks and settle on buying the No Touch option below:
Expiry: 2 weeks
If the price offer for this option is 15%, you will have to pay the seller an upfront premium amount equal to EUR 1,500 (EUR 10,000 * 15%).
- a) If the spot trades at 1.4400 in the duration of the contract period, this triggers the option and you do not receive any payout. You incur a loss of EUR 1,500; the premium amount.
- b) If the spot trades below the 1.4400 during the three week period, the option generates the payout of EUR 10,000.
These two examples show a trader who buys a binary touch option. Binary Touch Options are also sold. The same approach applies.
The investor decides on the strategy to use depending on his thinking that a particular level is going to be met or not. This approach is similar to trading spot but in binary touch options, profit is booked automatically and possible losses are limited. They therefore require lesser management during trading.
Another advantage is that binary trade options which have been purchased or sold can again be sold or purchased back before expiry. This provides extra flexibility allowing an investor to cut losses or take profits before binary touch options are triggered or expire.
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