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Trading Spreads with New Binary Options

Presented by: Jim Bittman, Senior Instructor The Options Institute at CBOE

CHICAGO BOARD OPTIONS EXCHANGE CHICAGO BOARD OPTIONS EXCHANGE

Trading Spreads with New Binary Options

Presented by: Jim Bittman, Senior Instructor The Options Institute at CBOE

Disclosures & Disclaimers

In order to simplify the computations, commissions have not been included in the examples used in these materials. Commission costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Options involve risks and are not suitable for all investors. Prior to buying or selling an option, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained from your broker or by calling 1-888OPTIONS, or from The Options Clearing corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606. Investors considering options should consult their tax advisor as to how taxes may affect the outcome of contemplated options transactions. SPX is a servicemark and VIX is a registered trademark of CBOE. Copyright 2008. Chicago Board Options Exchange, Incorporated. All rights reserved. 3

Session Outline
Binaries What the #@&% are They? Product specs Pricing concepts Simple Strategies Spread Strategies
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What are Binaries?

Yes or No options At Expiration: Payout = $100 or $0 Prices reflect the perceived probability that the underlying will reach or exceed the strike price at expiration.

CBOE Binary Call Options

Pay $100 if settlement value is at or above the strike price. European-style exercise (automatic)
Can only be exercised at expiration Can be traded on any business day

Expire and settle same as underlying

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Long SPX Binary 1250 Call at $0.40

+0.80 +0.60 Profit / (Loss) +0.40 +0.20 0.00 (0.20) (0.40) (0.60)
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1200

1225

1250

1275

1300

Below strike: BinaryAbove: Payout = $100 make $60 At or Expires Lose $40
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Short SPX Binary 1250 Call at $0.40

+0.80 +0.60 Profit / (Loss) +0.40 +0.20 0.00 (0.20) (0.40) (0.60)
][ ][ ][ ][ ][

1200

1225

1250

1275

1300

Below strike Keep $40or Above Pay $100 Lose $60 At

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Binary Options on SPX

Ticker Symbol Underlying Strike Intervals Last Trading Day Settlement Expiration BSZ SPX 5 Points Same as SPX Same as SPX Same as SPX
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Binary Options on VIX

Ticker Symbol Underlying Strike Intervals Last Trading Day Settlement Expiration BVZ VIX 1 Point Same as VIX Same as VIX Same as VIX
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Binaries More Facts

European Exercise (Automatic) Cash Settlement Settlement Amount $100 3 Expirations Available Quotes in Pennies
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Binaries Margin Requirements

Long Binaries: Pay Premium Short Binaries: Margin equals max risk ($100 premium)
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Pricing Impact of Index Level

SPX Days to Exp Volatility 1250 Binary Call O-O-M A-T-M I-T-M 1240 1250 1260 15 15 15 20% 20% 20% 0.42 0.50 0.58

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Pricing Impact of Index Level

1250 Binary Call vs. 1250-1251 Call Spread
1.00 0.80 Value 0.60 0.40 0.20 0.00
SP X 12 20 12 30 12 40 12 50 12 60 12 70 12 80

1250-51 Call Spread 1250 Binary

SPX
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Pricing Impact of Time A-T-M

SPX Days to Exp Volatility 1250 Binary Call A-T-M 1250 1250 1250 15 10 5 20% 20% 20% 0.50 0.50 0.50

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Pricing Impact of Time O-O-M

SPX Days to Exp Volatility 1250 Binary Call O-O-M 1240 1240 1240 15 10 5 20% 20% 20% 0.42 0.41 0.37

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Pricing Impact of Time I-T-M

SPX Days to Exp Volatility 1250 Binary Call I-T-M 1260 1260 1260 15 10 5 20% 20% 20% 0.58 0.60 0.63

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Pricing Impact of Time

Standard Options I-T-M A-T-M O-O-M Decrease Decrease Decrease Binary Options Increase No Change Decrease

Time affects binary options differently than standard options.

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Pricing Impact of Volatility A-T-M

SPX Days to Exp Volatility 1250 Binary Call A-T-M 1250 1250 1250 10 10 10 20% 25% 30% 0.50 0.50 0.50

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Pricing Impact of Volatility O-O-M

SPX Days to Exp Volatility 1250 Binary Call O-O-M 1240 1240 1240 10 10 10 20% 25% 30% 0.41 0.42 0.43

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Pricing Impact of Volatility I-T-M

SPX Days to Exp Volatility 1250 Binary Call I-T-M 1260 1260 1260 10 10 10 20% 25% 30% 0.60 0.58 0.56

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Pricing Impact of Rising Volatility

Standard Options I-T-M A-T-M O-O-M Increase Increase Increase Binary Options Decrease No Change Increase

Volatility affects binary options differently than standard options.

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Binary Spreads
Example: Buy SPX Binary 1225 Call @ 0.70 Sell SPX Binary 1275 Call @ 0.30 Net Cost 0.40 Constructed similar to a Bull Call Spread Payout at expiration within a range. Note: spreads involve extra commissions. 23

1225-1275 Binary Call Spread at $0.40

+0.80 +0.60 Profit / (Loss) +0.40 +0.20 0.00 (0.20) (0.40) (0.60)
][ ][ ][ ][ ][

1200

1225

1250

1275

1300

1225 Binary Pays $100 1275within a Expires profit = $60 Payout Binary range.
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Summary
Binary Calls on SPX & VIX
Payout at expiration if index at/above strike Price behavior similar to vertical spreads Time and volatility affect prices differently Binary vertical spreads payout within a range

CBOE The Innovation Exchange

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Thank You for Attending

Visit us at: www.cboe.com Questions? bittman@cboe.com Options Institute courses:
http://www.cboe.com/LearnCenter/Seminars.asp

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