Binary Touch Options, a simple yet powerful investment product

Binary Touch Options, though classified as exotic options, are arguably one of the simplest, yet most powerful investment products. They provide great leverage, full knowledge of potential profit and loss, and a limited potential loss even when shorting. In this article, and others to come, we will explore this instrument in detail. We start by introducing the mechanics of these options.

BTOs, like vanilla options, require the buyer to pay an upfront premium to the seller of the option. The buyer of the option will receive a fixed payout if a certain condition is met during the life of the BTO. That condition is simply the underlying spot rate must trade (or must not trade) at a specified level during the life of the option. The spot rate level on which the payout of the binary is dependent is called the trigger or the barrier.

We differentiate between 2 types of BTO:  “One Touch” and “No Touch”

• One Touch option: will generate a payout when the trigger level is reached by the underlying spot rate at anytime during the life of the option (from inception to expiry).
• No Touch option: will generate a payout when the trigger level has never been reached during the lifetime of the option (from inception to expiry).

Very simply we can say that a BTO lets the investor express the view that a certain spot level will trade or not during the life of the option.

Let’s look at some examples in EUR/USD to get us comfortable with the product. We assume spot is at 1.4400.

1.  Buying a One Touch Option

You believe that EURUSD will move to 1.4100 within the next three weeks and decide to buy the following One Touch option:

    Trigger:    1.4100
    Expiry:     3 weeks
    Payout:    EUR 50,000

The offer price for this option is 35%; the price is usually expressed as a percentage of the potential payout amount.  This means that you will pay an upfront premium of EUR 17,500 (EUR 50,000 * 35%).

• If you are proven wrong, and 1.4100 never trades during the next 3 weeks, you will receive no payout from the One Touch option; hence you will incur an overall loss of EUR 17,500.
• If, however, you are proven right and 1.4100 does trade in the spot market at any time during the life of the option, you will receive the payout amount of EUR 50,000 and therefore enjoy a net profit on the trade of EUR 32,500 (the payout minus the premium paid).

We can summarize the cash flows in the following table:

Note that potential profit and loss are known in advance, meaning the risk reward on the trade is know in advance as well. 

2. Buying a No Touch Option

You believe that EURUSD spot will stay below 1.4500 the next two weeks and you decide to buy the following No Touch option:

    Trigger:    1.4500
    Expiry:     2 weeks
    Payout:    10,000

The offer price for this option is 15%. This means that buying the option, you will pay the premium of EUR 1,500 (EUR 10,000 * 15%).

• If spot trades at 1.4500 within the next 2 weeks, the option is triggered and will not generate any payout. Your overall loss on the trade is the premium of EUR 1,500.
• However, if you are proven right and spot never trades at 1.4500 within the two weeks, the option will generate a payout of EUR 10,000.  Together with the premium paid, this becomes a net profit of EUR 8,500.

We summarize the cash flows in a table:


 
Again, potential profit, loss and risk reward are known prior to entering the trade.

As mentioned earlier, the investor decides which strategy to use based on his belief that a certain level will be reached or not.  This is, of course, the same approach when trading spot, but Binary Touch Options provide the added insurance that potential losses are limited and profit is automatically booked. Hence they require less management over the course of the trade. Adding the features together this gives a powerful yet simple and transparent product.

The above examples show an investor who decides to buy a BTO. But One Touch and No Touch options can also be sold.

Another specific advantage is that BTOs that have been bought or sold can be sold or bought back prior to expiry. This gives the investor additional flexibility in his trading, allowing to take profit or cut losses prior to the Binary Touch Options being triggered or expired.

Saxo Bank recently introduced Binary Touch Options for 6 of the most liquid currency pairs (EURUSD, GBPUSD, USDJPY, EURJPY, EURGBP and AUDUSD). They can be traded from the Saxo Bank Option Board in the “Prices and Trades” menu of the SaxoTrader trading platform.

For more information and examples please visit the BTO section on www.saxobank.com.