Using Binaries for Short Term Directional Trading

USing BinarieS for ShorT Term DirecTional TraDing

Binaries can be used to take an intra-day directional view on underlying markets, allowing the trader to go long or short in a market for a fraction of the margin necessary when trading more conventional contracts. And the usual benefits of Binaries apply a traders risk is strictly capped without the danger of being stopped out by a temporary adverse move. This presentation shows you how to use Binaries, either singly or strategically combined, to tailor your exposure to an underlying market. As an example, lets look at Nadexs US 500 Binaries, which settle based on an expiration value calculated by reference to the CME E-mini S&P 500 Futures. In this hypothetical example, the CME E-mini S&P 500 Futures for March are trading at 1252.00. The recent price action of these futures, as seen in the graph below, leads you to believe that the market has just broken through some short term resistance at the 1250.00 level. You believe that over the next couple of hours a market rally of a further 5-10 points is significantly more likely than a drop back below 1250.

Possible short term break out

Current level Possible resistance level

1252 1250

12pm

1pm

2pm

Consider the ladder of end-of-day (expiration at 4:15pm ET) US 500 Binary contracts typically available on Nadex:
Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262 Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250 Daily US 500 (Mar) > 1247 Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241 Daily US 500 (Mar) > 1238 Daily US 500 (Mar) > 1235 Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98 Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 -

2 hours to expiration, futures trading at 1252.0

These prices can be viewed as consensus probabilities generated by Nadex market participants. So, for instance, the generality of Nadex traders perceive only a 15-18% chance of the US 500 settlement being higher than 1256 at the end of the day. And they believe that the probability of the market holding above 1250 at the end of the day is between 66.9% and 70.4%.

Futures trading and options trading involve risk, which may result in financial loss, and are not suitable for everyone. Any trading decisions that you may make are solely your responsibility. The trading activity and other information presented herein are for informational purposes only. The contents hereof are not an offer, or a solicitation of an offer, to buy or sell any particular financial instrument offered on Nadex. S&P 500 is a registered mark of the McGraw-Hill Companies, Inc. CME and E-mini are registered marks of the Chicago Mercantile Exchange Inc. Nadex is not affiliated with these organizations and neither they nor their affiliates sponsor or endorse Nadex or its products in any way.

North American Derivatives Exchange, Inc. is subject to U.S. regulatory oversight by the CFTC.

Using Binaries for Short Term Directional Trading, June 2012

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If you believe in a 5 point rally by the end of the day, to approximately 1257, a strategy you could use is to buy the >1256 contract at 18. For each contract purchased you would be risking $18 to potentially make a profit of $82. If you perceive the potential for a rally of around 10 points you could buy the >1259 contract at 6. In this case, for each contract purchased, you would be risking $6 to potentially make $94. Or you might even buy the >1262, risking $2.80 to potentially make a profit of $97.20. Taking a less bullish view, if you believe the market will simply hold above the key 1250 level, you could buy the >1250 contract at 70.4, risking $70.40 to potentially make a profit of $29.60.
Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262 Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250 Daily US 500 (Mar) > 1247 Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241 Daily US 500 (Mar) > 1238 Daily US 500 (Mar) > 1235 Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98 Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 -

Back a strong (approx 10 pt) rally by buying one of these contracts very small risk, very large potential reward for an outcome the market believes is very unlikely Back a moderate (approx 5 pt) rally by buying this contract small risk, large potential reward for an outcome the market believes is pretty unlikely Back any kind of rally, and still profit even if there is a small fall, by buying this contract large risk, small potential reward for an outcome the market believes is somewhat likely

2 hours to expiration, futures trading at 1252.0

The following slides show the kinds of P&L profile you can generate with these and other strategies.

long 5 loTS of >1256 @ 18

500 400 300 200 100 0 1247
Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262 Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250 Daily US 500 (Mar) > 1247 Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241 Daily US 500 (Mar) > 1238 Daily US 500 (Mar) > 1235 Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98 Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 Buy 5

Potential profit on 5 lot position (= $410 )

Potential loss on 5 lot position (= $90 )

1250

1253

1256

1259

1262

1265

- 100 - 200
Current market (= 1252) Collateral required to enact this intraday binary strategy: $90

2 hours to expiration, futures trading at 1252.0

In this strategy, going long the >1256 contract, you would be backing the underlying market to be more than 4 points higher by the end of day. The consensus of other Nadex participants is that this is only 15-18% likely. Assuming you hold the position until expiration, each contract purchased would risk $18 to potentially make $82 (you buy at 18, and final settlement must be either 0 or 100). In this example 5 lots are being traded, so your maximum possible loss (and total required collateral) is 5 x 18 = $90. Note that you do not have to hold the position until expiration you might choose to exit early if the market moves up a few points in the short term and you do not believe the rally will be sustained. The price at which you could exit under these circumstances will depend on the precise size of the rally and the amount of time still remaining until expiration, as these two factors will shape the new probability that the >1256 outcome will occur.

Example does not include fees and commissions, which may vary by broker. Example assumes all positions are entered into by trading at the available offer price rather than working orders at a more favorable level.

North American Derivatives Exchange, Inc. is subject to U.S. regulatory oversight by the CFTC.

Using Binaries for Short Term Directional Trading, June 2012

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long 5 loTS of >1253 @ 42.3

400 300 Potential profit on 5 lot position (= $288.50 ) 100 0 Potential loss
on 5 lot position

Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262 Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250
1250 1253 1256 1259 1262 1265

Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98

Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 Buy 5

200

1247 -100 -200 -300

Daily US 500 (Mar) > 1247 Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241 Daily US 500 (Mar) > 1238

(= $211.50 )

Current market (= 1252) Collateral required to enact this intraday binary strategy: $211.5

Daily US 500 (Mar) > 1235

2 hours to expiration, futures trading at 1252.0

This strategy, going long the >1253 contract, backs the underlying market to be more than just 1 point higher by the end of day. This is a less bullish view than the previous strategy and the consensus of nadex participants is that the outcome is more probable, at a likelihood of 38.3-42.3%. Because success is more likely, your risk/reward ratio is less favorable than in the previous example. assuming you hold the position until expiration, each contract purchased would risk $42.30 to potentially make a profit of $57.70 (you buy at 42.3, and final settlement must be either 0 or 100). In this example 5 lots are being traded, so your maximum possible loss (and total required collateral) is 5 x 42.3 = $211.50. Once again, though, you are not tied in to risking the whole $211.50 by waiting until expiration. If you feel the position is not working out (or if it is going right and you want to take an early profit) you can place an order to exit early. Provided your order is placed at a level which is attractive to other participants, you can close out your exposure to cap a loss or lock in a profit.

long 5 loTS of >1259 @ 6

500

Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262 Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250 Daily US 500 (Mar) > 1247 Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241
1250 1253 Current market (= 1252) Collateral required to enact this intraday binary strategy: $30 1256 1259 1262 1265

Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98

Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 Buy 5

400 Potential profit on 5 lot position (= $470 )

300

200

100

Potential loss on 5 lot position (= $30 )

0 1247 -100

Daily US 500 (Mar) > 1238 Daily US 500 (Mar) > 1235

2 hours to expiration, futures trading at 1252.0

This is an example of an extremely bullish strategy, backing the market to be more than 7 points higher at the end of the day by going long the >1259 contract. The consensus of Nadex participants is that the outcome is very improbable, at a likelihood of just 3-6%. Because success is considered so unlikely by other participants, your risk/reward ratio is far more favorable than in either of the previous examples. Assuming you hold the position until expiration, each contract purchased would risk $6 to potentially make a profit of $94 (you buy at 6, and final settlement must be either 0 or 100). In this example 5 lots are being traded, so your maximum possible loss (and total required collateral) is 5 x 6 = $30. A full payout in this example is, by definition, extremely unlikely. But note that a short term rally of a few points may, depending on precise timing and magnitude, lift the consensus bid above 6 and allow an opportunity to take a profit on the strategy, even if the final goal of a 7 point rally is never achieved.

Example does not include fees and commissions, which may vary by broker. Example assumes all positions are entered into by trading at the available offer price rather than working orders at a more favorable level.

North American Derivatives Exchange, Inc. is subject to U.S. regulatory oversight by the CFTC.

Using Binaries for Short Term Directional Trading, June 2012

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LOng 5 LOts Of >1250 @ 70.4

200 Potential profit on 5 lot position (= $148 )

Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262
1250 1253 1256 1259 1262 1265

Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98

Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 Buy 5

100

0 1247 -100 Potential loss on 5 lot position (= $352 )

Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250 Daily US 500 (Mar) > 1247 Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241 Daily US 500 (Mar) > 1238 Daily US 500 (Mar) > 1235

-200

-300

-400 Current market (= 1252) Collateral required to enact this intraday binary strategy: $352

2 hours to expiration, futures trading at 1252.0

At the opposite end of the scale you could back a strategy that pays off in the event of any kind of rally, regardless of size, and even still pays off in the event of a small fall in the market. The chart above shows the payoff profile for a long 5 lot >1250 position. Given the market is currently above 1250, it is more likely than not that this Binary will settle at 100; Nadex participants have, in this example, reached a consensus view that the exact probability stands at 66.9-70.4%. Because success is considered so likely by other participants, your potential risk in this case is larger than your potential reward. Assuming you hold the position until expiration, each contract purchased would risk $70.40 to potentially make a profit of $29.60 (you buy at 70.4, and final settlement must be either 0 or 100). In this example 5 lots are being traded, so your maximum possible loss (and total required collateral) is 5 x 70.4 = $352. As ever, you are not tied in until expiration; an early exit from this position is possible, provided your exit order is at a level attractive to other market participants.

long 2 loTS of >1253 @ 42.3, long 3 loTS of >1256 @ 18

400

Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262 Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250 Daily US 500 (Mar) > 1247 Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241 Daily US 500 (Mar) > 1238 Daily US 500 (Mar) > 1235

Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98

Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 Buy 3 Buy 2

300 Potential profit on 5 lot position (either $61.40 or $361.40 )

200

100

Potential loss on 5 lot position (= $138.60 )

0 1247 -100

1250

1253

1256

1259

1262

1265

-200

Current market (= 1252) Collateral required to enact this intraday binary strategy: $138.6

2 hours to expiration, futures trading at 1252.0

Here is a more elaborate strategy designed to spread the risk of taking a bullish Binary view. In this case the 5 lot position is split over two contracts, the >1253 and the >1256. If you do not exit early and instead hold the strategy to expiration you stand to make a profit of $61.40 (in the event of a settlement level above 1253 but no higher than 1256) or $361.40 (in the event of a settlement level above 1256). If the market finishes at or below 1253 you will lose $138.60.

Example does not include fees and commissions, which may vary by broker. Example assumes all positions are entered into by trading at the available offer price rather than working orders at a more favorable level.

North American Derivatives Exchange, Inc. is subject to U.S. regulatory oversight by the CFTC.

Using Binaries for Short Term Directional Trading, June 2012

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long 1 loT of >1253 @ 42.3, long 1 loT of >1256 @ 18, long 3 loTS of >1259 @ 6
500 400 Potential profit on 5 lot position (either $21.70 300 200 100 0 1247 -100 -200 Current market (= 1252) Collateral required to enact this intraday binary strategy: $78.3

Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262 Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250 Daily US 500 (Mar) > 1247
1250 1253 1256 1259 1262 1265

Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98

Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 Buy 3 Buy 1 Buy 1

or

$121.70 or $421.70 )

Potential loss on 5 lot position (= $78.30 )

Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241 Daily US 500 (Mar) > 1238 Daily US 500 (Mar) > 1235

2 hours to expiration, futures trading at 1252.0

Here is an example of a 3 contract strategy designed to ratchet up a payout in the event of a large rally. In this case the 5 lot position is split over three contracts, the >1253, the >1256 and the >1259. Here your maximum risk, should you choose to hold the position until expiration, is capped at $78.30. A settlement level above 1253 will result in a profit of either $21.70, $121.70 or $421.70, depending on just how strong the market is by the end of the day. You can also use Binaries in conjunction with conventional futures contracts. The final few examples look at the effect of going long of a single lot of the CME E-mini S&P 500 Futures, while providing temporary protection against a sudden adverse move by shorting some US 500 Nadex Binaries.

Possible short term break out

Current level Possible resistance level

1252 1250

12pm
Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262 Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250 Daily US 500 (Mar) > 1247 Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241 Daily US 500 (Mar) > 1238 Daily US 500 (Mar) > 1235 Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98 Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 -

1pm

2pm

If you go long of the CME E-mini S&P 500 Futures, selling some of these Binaries can provide protection against an unexpected short term drop in the market

2 hours to expiration, futures trading at 1252.0

Example does not include fees and commissions, which may vary by broker. Example assumes all positions are entered into by trading at the available offer price rather than working orders at a more favorable level.

North American Derivatives Exchange, Inc. is subject to U.S. regulatory oversight by the CFTC.

Using Binaries for Short Term Directional Trading, June 2012

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shOrt 5 LOts Of >1250 @ 66.9, LOng 1 LOt CME E-MInI s&P 500 futurEs @ 1252
400 300 200 100 0 1238 -100 -200 Current market (= 1252)
Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262 Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250 Daily US 500 (Mar) > 1247 Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241 Daily US 500 (Mar) > 1238 Daily US 500 (Mar) > 1235 Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98 Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 Sell 5 (and buy 1 lot of futures)

1241

1244

1247

1250

1253

1256

400 200 0 1238 -200 -400 -600 -800 Standalone Futures P&L Net Strategy P&L 1241 1244 1247 1250 1253 1256

2 hours to expiration, futures trading at 1252.0

Standalone Binary P&L

Strategy boosts futures P&L by $334.50 in this region

Strategy reduces futures P&L by $165.50 in this region

A short position in the >1250, taken out at a price of 66.9, means that for each contract you stand to make $66.90 for a risk of $33.10. Going short of 5 lots, in conjunction with a long position of 1 lot in the futures, results in boosting your P&L by $334.50 in the event of a settlement at or below 1250. This comes at the cost of reducing your P&L by $165.50 in the event of a settlement above 1250.

Example does not include fees and commissions, which may vary by broker. Example assumes all Binary positions are entered into by trading at the available bid price rather than working orders at a more favorable level. Payout profiles assume futures position is closed out at a level identical to the Nadex-calculated US 500 Expiration Value.

North American Derivatives Exchange, Inc. is subject to U.S. regulatory oversight by the CFTC.

Using Binaries for Short Term Directional Trading, June 2012

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shOrt 5 LOts Of >1247 @ 87.3, LOng 1 LOt CME E-MInI s&P 500 futurEs @ 1252
500 400 300 200 100 0 1238 -100 Current market (= 1252)
Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262 Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250 Daily US 500 (Mar) > 1247 Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241 Daily US 500 (Mar) > 1238 Daily US 500 (Mar) > 1235 Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98 Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 Sell 5 (and buy 1 lot of futures)

1241

1244

1247

1250

1253

1256

600 400 200 0 1238 -200 -400 -600 -800 1241 1244 1247 1250 1253 Standalone Futures P&L Net Strategy P&L

2 hours to expiration, futures trading at 1252.0

1256 Standalone Binary P&L

Strategy boosts futures P&L by $436.50 in this region

Strategy reduces futures P&L by $63.50 in this region

Cheaper (but less comprehensive) protection can be engineered by taking a short position in the >1247 at a price of 87.30, leaving you with a per-contract potential profit of $87.30 and a maximum possible per-contract loss of $12.70. Going short of 5 lots, in conjunction with a long position of 1 lot in the futures, results in boosting your P&L by $436.50 in the event of a settlement at or below 1247. This comes at the cost of reducing your P&L by $63.50 in the event of a settlement above 1247.

Example does not include fees and commissions, which may vary by broker. Example assumes all Binary positions are entered into by trading at the available bid price rather than working orders at a more favorable level. Payout profiles assume futures position is closed out at a level identical to the Nadex-calculated US 500 Expiration Value.

North American Derivatives Exchange, Inc. is subject to U.S. regulatory oversight by the CFTC.

Using Binaries for Short Term Directional Trading, June 2012

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shOrt 1 LOt Of >1250 @ 66.9, shOrt 2 LOts Of >1247 @ 87.3, shOrt 2 LOts Of >1244 @ 96.2, LOng 1 LOt CME E-MInI s&P 500 futurEs @ 1252
500 400 300 200 100 0 1238 -100 Current market (= 1252)
Contract Daily US 500 (Mar) > 1268 Daily US 500 (Mar) > 1265 Daily US 500 (Mar) > 1262 Daily US 500 (Mar) > 1259 Daily US 500 (Mar) > 1256 Daily US 500 (Mar) > 1253 Daily US 500 (Mar) > 1250 Daily US 500 (Mar) > 1247 Bid 3 15 38.3 66.9 87.3 96.2 97.6 98 98 Offer 2 2.1 2.8 6 18 42.3 70.4 90.3 98.9 Sell 1 Sell 2 Sell 2 (and buy 1 lot of futures)

1241

1244

1247

1250

1253

1256

Daily US 500 (Mar) > 1244 Daily US 500 (Mar) > 1241 Daily US 500 (Mar) > 1238 Daily US 500 (Mar) > 1235

2 hours to expiration, futures trading at 1252.0

600 400 200 0 1238 -200 -400 -600 -800 Strategy boosts futures P&L by either $33.90 or $233.90 or $433.90 in this region Strategy reduces futures P&L by $66.10 in this region 1241 1244 1247 1250 1253 Standalone Futures P&L Net Strategy P&L 1256 Standalone Binary P&L

Again, many more elaborate strategies are possible. In this one the 5 lot position has been split between 3 contracts, giving extensive downside protection to your long E-Mini position, at the cost of reducing P&L by $66.10 in the event that all the Binaries settle in the money.

range of markeTS
We offer contracts on: Equity Indices: US 500, Wall Street 30, US Tech 100, US SmallCap 2000, Germany 30, Japan 225, FTSE 100 Spot FX: EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD/USD, GBPJPY, EURJPY Energies: Crude Oil, Natural Gas Metals: Gold, Silver, Copper Agriculturals: Corn, Soybeans Economic Events: Initial Jobless Claims, Fed Funds, ECB Rate, Nonfarm Payrolls, Unemployment Rate

Example does not include fees and commissions, which may vary by broker. Example assumes all Binary positions are entered into by trading at the available bid price rather than working orders at a more favorable level. Payout profiles assume futures position is closed out at a level identical to the Nadex-calculated US 500 Expiration Value. Futures trading and options trading involve risk, which may result in financial loss, and are not suitable for everyone. Any trading decisions that you may make are solely your responsibility. The information presented herein is for informational purposes only. The contents hereof are not an offer, or a solicitation of an offer, to buy or sell any particular financial instrument offered on Nadex.

North American Derivatives Exchange, Inc. 311 South Wacker Drive Suite 2675 Chicago, IL 60606 Phone: 312-884-0100 Fax: 312-884-0940 Email: customerservices@nadex.com www.nadex.com

North American Derivatives Exchange, Inc. is subject to U.S. regulatory oversight by the CFTC.

Using Binaries for Short Term Directional Trading, June 2012

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