1. Ladder options:
As the name suggests, a ladder option is structurally similar to a ladder. A ladder consists of several steps.
Similarly, a ladder options contract will have several target levels. If the price pierces through all the levels in a ladder options contract, then a payout ranging from 500% to 1500% (depending on the broker) is paid by the broker.
A ladder options contract can have price levels above and below the prevailing price of the underlying asset. Nowadays, most of the brokers offer both call ladder and put ladder contracts.
If the trader expects the price to go up in a steep manner, then a ladder options contract with target levels above the current price level should be bought and vice-versa.
A ladder contract can be traded successfully during the central bank’s interest rate announcements. This is particularly true with major currency pairs, which show heightened volatility during interest rate announcements.
It should be noted that even if the price breaches a particular level and then reverses, the payout for that level would be credited.
2. Pair trading:
The contract would involve two closely related assets. A trader should determine which asset would outperform the other within the expiry period. If the forecast turns out to be true, then the trader will receive a payout of up to 350% on the investment. The pair trading is considered to be market neutral. Two different formats of pair trading are offered by brokers. One is fixed pairs trading and the other one is floating pairs trading.
i. Fixed pairs trading:
In this case, the performance of two assets is taken into consideration, only after a contract is purchased. What had happened till then does not
For example, let us consider that a trader chooses to trade eBay (EBAY) and Amazon (AMZN) pair. The trader forecasts that Amazon will outperform eBay during the next five days. So a pair trading contract (weekly expiry) with put option on eBay/Amazon pair is bought. Let the invested sum is $100 and the payout is 350%.
The system records the share price of eBay and Amazon at the time of purchase of the contract. Let the share price of eBay is $25, while the share price of Amazon is $560 at the time of purchase. At expiry, let the share price of eBay and Amazon is $26.25 and $590 respectively. This means that eBay had gained 5% from the time of purchase of the contract, while Amazon had gained 5.35% in the same time. Thus, the forecast turns out to be true and the trader will receive $450 in his account.
ii. Floating pair trading:
The only difference in this kind of contract is that the performance is measured over a pre-determined period of time. To put it simple, irrespective of when a contract is purchased, the countdown for an option contract begins in a pre-determined time. For example, it can be one day or even one week. In the same example discussed above, the performance of eBay at expiry is calculated using the opening price at the beginning of the week and the closing price at the end of the week.
Likewise, the performance of Amazon is calculated. By comparing the net gains of eBay and Amazon for the entire week, the best performer and the
trade result is decided.
As it can be understood, the share price of eBay or Amazon at the time of purchase of the contract is insignificant in a floating pairs trading.
Furthermore, the payout from the trade at a given time depends on which asset is outperforming the other and the margin of gain. The yield would
constantly change as the performance metrics keep changing.
Let us assume that Amazon leads eBay with a net gain of 4% at the end of 3 days. Now, with just two days remaining for expiry, if a trader wishes to buy a put option on the eBay/Amazon pair, then the yield for a successful trade would be hardly 25%. The reason is that it would be quite hard for eBay to cover the gap in a matter of two days. So, considering the fact that the probability of eBay outperforming Amazon is quite low, the
yield would be naturally low.
On the other hand, if a trader wishes to bet on a call option on the eBay/Amazon pair, the payout offered would be more than 150%.
However, the chance of success of the trade is close to nil. Thus, the contract derived such a name because of the floating yield. A trader can also exit earlier from floating pairs trading. This would enable a trader to manage funds effectively. The maximum yield is usually limited to 350% of the investment amount.
As binary options trading started growing exponentially, brokers began offering additional facilities to clients. We shall look at them in the next chapter.