The below is not stating you should trade any specific instrument. If choosing between verticals and nadex binaries then this may help. Its simply a comparison of the two based on comparison statements made in this thread. Statement: A nadex binary price 0-100 can be derived using the same formula as the formula for a delta 0-100 is somehow magically automatically disassociating it with a vertical spread and therefore makes the pricing model invalid. True False Statement: A simple and accurate pricing model on tiered Nadex binary contract is priced so as to match the delta of a call strike of the underlying instrument with the same expiration...True or False Statement: Nadex binaries are nothing more than poorly priced verticals and someone should only do vertical ETF versus a binary on Nadex as Vertical ETF's are better "poor pricing structure of binaries" ...True or False Statement: fees and spreads will kill you on binaries making it where you can't profit.. True or False Evidence of the above statements : versus "I'm right, your wrong, your stupid, it can't be this simple cause I'm this smart, stop talking" I definitely see how one could think binaries are priced like verticals. So cool I will go with that. However this is because of the fact that they are both using the black scholes model. If you want to... Just as I said if you know the delta of a call you could know a binary price. Can I give you a much more complex formula yes is it necessary will it make me a better trader helping me make more money -no..trying to price a vertical like a binary IMHO is a much more complex way to arrive at the same destination where it is much easier to price the delta of a call 0 to 100.... In either case... lets put the math down. on the comparison with some evidence.... However, the varying payout of a vertical requires maximum movement. Whereas a binary receives full payout if it is just 1/10 of 1 tick in the money at expiration to make 100% of profit potential. So it is not simply comparing a capped profit and risk binary option to another capped profit and risk payout vertical. Being the main difference is the Max payout on a binary if it expires ITM but a lower payout or even a loss on a vertical depending on where it expires in the range. As shown here the binaries on Nadex whether ITM/ATM/OTM line up with the delta of the correspond call strikes on ES options that have the same expiration time - this is simple and accurate and has yet to be disproven and can be found in binary white papers and therefore can theoretically and practically be used to price a binary. For the best accuracy you would need to extract the IV based on the pricing as your X factor first. And then use that IV to help price them out. Yes there is skew etc.. so you would need to reprice as both time and IV change over time However, the same applies to call and put vanillas and verticals and bears oh my.... Simply change the model factoring in time to expiration, price in relation to strike movement, and potentially IV to obtain the delta and you could obtain what the price of a binary would be should the underlying move, iv change, and or time pass. If you think I am wrong. Great show one example any example that proves otherwise. Comparing the SPY 175-175.5 binary to the 1754.5 spread (the challenge being and before it said...though similar they are not the same as one is based on the SPY and the binary is based on ES... but just for examples sake we will go with both being ATM) This is referencing the post earlier (noted below - regarding a the binary price posted by drownpruf and the SPY verticals provided by SLE near the same time. [/URL] ]http://content.screencast.com/users/Stephen08540/folders/Jing/media/fae73f45-82ad-4e85-9d69-ad2d645bbff9/2014-02-05_1722.png This is best exhibited in this screenshot and explained a bit more detail below... http://screencast.com/t/O2mVKmCpiPWN The fees are substantially lower on Nadex binaries in comparison to the vertical. The bid ask spreads are in fact higher on the binary in comparison to the vertical. In both cases you don't pay the bid ask spread if held to expiration. So in comparing to holding to expiration the bid/ask spread is void. The fees will be lowered on the verticals if exercised versus closing before expiration. Exercise risk exist on the verticals but not on the binaries. Despite the higher spreads combined with the lower fees the binaries versus verticals, binaries easily surpasses that of the vertical spreads in profit in all price movement ranges due to a binaries all (in the money by 1/10th of 1 tick) or nothing payout (OTM) versus a variable payout at best on a vertical and a nothing payout if it expires OTM Bottom line in all cases more can be made using the binaries than that of the debit spread on a buy to expiration comparison Fees on Vertical I assumed based on one of the brokers listed on this site that your commissions are 8.50 + .15 per contract (you did 2000 verticals (requiring a bought and sold call) so that is 4000 contracts x .15 + 8.50). Maybe you have a better rate but just to level out the playing field. Making your cost on just fees $608.50. Fees on Binary Fees are capped at $9.00 per order submitted (even if partial filled etc.. then later filled it will still be $9.00 so long as the order is not changed. So being .90 a contract once you do 10 or more contracts you fees will not exceed $9.00 on entry and $9.00 on exit for a total of $18 Fee Summary Vertical Binary $608.50 Versus $18.00 Exercise Risk & Impact on Fees & Paying Spread On Vertical Since SPY has American Style options if the sold call is exercised you will be assigned short the SPY shares. (i know you know this just for other readers who don't). So its important to know when doing the vertical on the vertical assuming say the market flies up you have excessive risk on the sold call which would most likely lead to you exercising the long call to cover the short SPY shares and avoid a "possible margin call" depending on the account size. Assume the cost is say $15.00 per strike. So you have potential $30 in fees but if this is done it would save you half the commission as most brokers at least the ones i use don't charge you both its one or the other. If you are not exercised upon you will probably (depending on your broker) not pay any fee on the sold option that expires OTM and if the long call expires OTM you will also not pay any commission to exit (depending on the broker). But if you hold to expiration to take profit you will deal with the long calls being excercised etc.. and have to deal with all that. If both options settle OTM you will not pay bid/ask spread meaning it will not increase your cost If both options settles ITM you will not pay bid/ask spread meaning it will not decrease your profit (saving you $4608.50 in spread) on a $100,000 notional position) Exercise Risk on Nadex Binary And Impact on Fees and Spread Cost There is no exercise risk to worry about or deal with. If it settles ITM it will cash settle. If the binary settles OTM there is no fee so you will not pay the $9.00. If it settles OTM you will not pay bid/ask spread meaning it will not increase your cost If it settles ITM you will not pay bid/ask spread meaning it will not decrease your profit (saving you $6,000 in spread on a $100,000 notional position) So what is most likely is if you are profitable (close to max profit say) you will close the position before expiration I am assuming. This would require you pay the bid ask spread Advantages If you hold it and it goes to max profit and you exercise it then you avoid paying the bid/ask spread as you are not paying to exit out of the trade as you are getting the Intrinsic value difference between what was paid and the (ceiling) assuming long) and only paying the exercise fee of $30 ($15 x 2 strikes) further saving you on commissions The only advantage I can see of comparing a vertical to a binary is the slighly lower bid ask spread. Though this is defintely not always the case as just a couple strikes up or down and the bid ask spread no the vertical ie an OTM or ITM debit/credit spread can have substantially higher bid ask spread than a binary contract. Beyond that the advantage of full payout for being only 1/10th of a tick in the money, versus variable payout with full payout only occurring upon maximum movement at above the sold call (or sold put if a put vertical) (assuming debit for simplicity). Further more the hours on the ETF's are limited so you can not adjust your position directly if there is an adverse move in the market after hours. You pay higher fees on the ETF's . You are waiting a week on a trade or having to pay bid/ask spread versus doing shorter intraday, 8 hour, or 23 hour binary contracts. But if you like weekly the binary contracts still exist. Obviously you don't have to wait a week etc... but you do have to pay bid ask spread and substantially higher fees not do so versus collecting maximum intrinsic value. Don't agree offer proof and evidence showing otherwise versus theoretical statements. Lets make this actually beneficial.
Inaccurate, there is a varying payout/profit on a vertical depending on where the underlying market is in relation the where it is in relation to the bought price and the upper strike on the vertical. You do not get full payout on a vertical debit spread if ie if it expires 10 ticks lower than the upper strike on the vertical. But on a binary you receive full payout if it is just 1/10th of a tick above the lower strike. (or if sold at or below the binary strike). In between before expiration sure there is equivalence however this is not the case at expiration if the price is not above the upper strike on a bought vertical debit spread or if the underlying is not below the lower strike on a sold vertical debit spread you will not receive a full payout. That math is the math show where the example is wrong. As a wise man once said
Call delta is bound between 0 and 100. A digital (nadex binary) will be 0 or 100 as well as of expiration. Yes the payout is capped on both a vertical and a digital. On a digitial is is a full payout. On a vertical it is a varying payout depending upon underlying settlment price in relation to the upper and lower strike as stated previously. And of course agreed it is not capped on a call I already wrote this and have not wrote anything contrary to this.
The evidence has been presented clearly... Prosection (aka Drownpuf) "No further questions" Defense (aka jackieo79) "I rest my case"
I can't find Nelken's book on exotics, but the maths are there (and in my sheet) for OTC replication. I'll transcribe it when I find it. it's lacking linear equations so I can't post the symbology.
Izzy Nelken, 2000 Assuming a digital call paying $1 if the underlying is above $100 at maturity, we compare it with a portfolio consisting of a long position in a vanilla call (K = 100) and a short position in a call (K = 101). The replicating portfolio pays $0 below $100 and $1 above $101, but between $100 and $101, the spread is only an approximate hedge for the binary option. It is to be observed that the narrower the spread gets, the more exact the hedge becomes: e.g., a spread built from ten long calls (K = $100) and ten short calls (k = $100.10) is a better hedge for the above digital call option except for the region between $100 and $100.10. Generalizing the procedure, the digital option struck at K and paying $1 can be hedged by going long on (n) European options struck at K and short on n(n) European options struck at K + 1/n. Consequently, we can draw the conclusion that binary options can be synthesized using vertical spreads of vanillas. In the case of digital options, the static replication method as compared to dynamic hedging has the advantage of not having to rebalance the weights of the portfolio and therefore no additional rebalancing costs are incurred. However, static hedging of digitals has its limitation given by the applicability of the previous two formulae. In order to be valid from a financial point of view, two assumptions have to be made which would require a perfectly liquid market for vanilla options as a setting (which is generally not the case in practice). The first assumption requires the availability of an infinite number of plain vanillas with all strikes and maturities. Obviously, if an approximation for a static hedge is made with a limited number of vanillas, this could lead to errors similar to those generated from discrete rebalancing in dynamic hedging. Secondly, vanilla options with strikes around the strike price of the corresponding cash-or-nothing call/put (slightly higher and lower) should be available at the same time; this is generally not the case in organized exchanges. (Zhang, 1998). A strip of verticals with identical PNL convexity is difficult to obtain with fixed and arbitrary strikes on listed vanillas, which is why the guy can scream for proof and scream he's right when no examples are forthcoming. In the sense that a lookback option can be replicated with a strip of touches; the same can be done with vertical spread/digital replication. I will try to post a listed-vanilla strip of verticals on a high-notional ticker with standard strike widths (GOOG or PCLN). and a corresponding ATM digital assuming 50/100. Maybe sle will do the same.
I thought I was on ignore? The prosecution calls one more witness... The mathematical equations sound fantastic. Can't Wait! To help you find your lost book maybe this is it on Amazon http://www.amazon.com/The-Handbook-...047/ref=dp_top_cm_cr_acr_txt?showViewpoints=1 Wonder though if it will actually provide a reality based practical application beyond a "exotic math course". I will have to order it also. I am sure it will sound really intelligent. But black scholes equation of delta of a call strike, also well as proven already, shows the price of a binary. Whether it is understood by the "smart" people or not. Im not challenging your intelligence or ability to make fortunes in the market. I hope you have and continue to do so. But the ability to contradict a statement with evidence that proves its is inaccurate versus saying no this is how I do it. Sometimes there are two equations to the same solution. Personally so long as accurate i prefer the simpler one. That is unless it can somehow be disproven. Which seems to constantly be evaded over and over again along with every other point made and just stated its not correct...I mean its math its not hard to disprove when someone is wrong. Equation A says delta is X - binary price is X or its not... not hard to contradict Make sure to not just use over under binaries, touch binaries, etc.. make sure to reference tiered binaries allowing opening and closing before expiration so you get the right formula. Just want to help you stay on the right path. I just hope to see something you know, that is useful... that we as traders can use well to make money as ummm that's why we are here..Also specifically addressing and proving the points made where wrong as well they have not been so far. Simple screenshots of live markets with some equations that show accuracy or inaccuracy Make it count provide more than transcription as all of us normal people could understand it and want to learn how to use it to make money. Thank you for taking all the effort.
Your fast way to go... Okay so you can also price binaries as verticals cool as he said so. You know what I think i already said...so well I agreed that yes WHILE open it can be viewed as a SIMILAR instrument on pricing. Expiration is where it varies. That is why it can be priced and hedged with and that I do appreciate. That is a cool new concept for me to look at as a way to potentially hedge. Thank you. Though as he points out finding liquid verticals on the exact underlying markets for binaries on futures and forex markets that are tiered and have opens and closes with the same strikes and expirations. Well is a little more difficult to implement. And probably has little use to me as a trader unless I am big on trading weeky binaries (why make in a week what i can make in a hour or a day... But I see the potential application. Bravo But you have yet to disprove anything I have said.. My point was is a delta formula also works for pricing..along with a slew of other points that have yet to be counterclaimed. He does not say the payout is the same. I mean come on its a vertical you knw how verticals work. If they expire within the upper and lower strike your not getting full payout between the strikes at expiration they are variable payout. If a binary can only expire ITM or OTM thats it. A vertical can be fully ITM, fully OTM, or have variable. So as of expiration there is a difference arguing that well is just a bit nuts but I don't believe thats your point as you know this already. Example shown previously of variable payout at expiration versus all or nothing payout on a binary.
I will use small words and short sentences, European digital can be priced and risk managed as an arbitrarily tight call spread (or put spread, same thing). Nadex or any other provider will use this replication for pricing/risk-managing and pass the cost on to you via bid/offer. This replication is model independent, does not matter if you use Black-Scholes or Normal model or any option model Spread replication captures the skew of the implied distribution. Black-Scholes analytical digital price does not, the difference is pretty large. Delta is not the same as digital probability, N(d2) is - using delta is an OK approximation, but it's not ok for risk management purposes Replication, unlike an analytical model, produces manageable delta (non-Dirak delta) Replicating nature of the digital means that you don't need a dedicated "binary" exchage and no real value is added by such an exchange aside from additional fee and bid/ask spread generation one sided American binary is not identical in price to 2x of the European binary because of the vega convexity and vega-spot cross effect. There is no perfect replication portfolio there is a pretty good chance that you are a Nadex rep Please prove me wrong on any of these points, I double dare you