One of the least known option trading strategies involves the use of a fixed yield, hourly expiration binary option. Although these options are essentially unknown to most traders, they have the ability to create strong short term returns with no associated transaction costs.
For those not familiar with them, here's a quick run down of the characteristics of binary options:
1. Binary options trade at the spot price of the stock (no spread, no put or call premiums)
2. Some brokers allow you to trade them commission free
3. The holding period yield is 60% -75% depending on the security
4. The holding period or expiration is either at the top of the hour or the end of the day
5. Only the best known, most highly liquid securities are traded this way
6. They are bought and sold in fixed dollar increments (much like mutual funds)
7. They are not marginable
8. The size of a stock price movement is irrelevant – only the direction of movement matters
It should be apparent how option trading strategies to use binary options can evolve based on the aforementioned characteristics. Two advantages to exploit are the fixed dollar contacts and the and the zero transaction costs. What option trading strategies might be used given these characteristics?
One example would be to use them as short term insurance against a reversal in a long-term (long or short) position taken. Buying a hundred shares of Microsoft at $ 24 / share for example, then pairing it with a 60% yield $ 400 end of day contract for a binary put buys insurance against a ten percent drop in Microsoft. Even a one cent end of day drop in Microsoft earns $ 240 in profit on the put option trade, representing 10% of your long MSFT position.